Business estate planning, or succession planning, looks at arranging your business affairs should a key person or owner of the business exit. The aim is to avoid any detrimental effect to the continuity, revenue or profit of the business.

When there is no formal plan or agreement in place between owners, it can result in beneficiaries inheriting a controlling interest in the company.  The beneficiaries may not have the skill, experience or expertise in playing an active role within the business. They may simply want to sell their share. This can lead to various risks including:

• Legal action over business valuations
• A beneficiary deciding to take an active role within the business against the wishes of the existing owners
• Without a plan in place, existing owners may be forced to sell to another party just to pay out the departing owners’ estate
• The departing owners’ beneficiaries or estate continue to claim business profits without working in the business

Having a detailed agreement between business owners provides legal certainty if the unforeseen occurs. It provides the remaining owners the right to buy the share of the departing owner, whilst also ensuring that the departing owners estate or beneficiaries are paid an agreed amount as consideration for the shares in the business. The agreement would detail the events that trigger the agreement, such as death and disability, a method of valuing the share of each owner, the buy and sell obligations of the business and the means of funding the buy/sell.

The funding of the buy/sell transaction is important and there are various options to consider:

Cash Sinking Fund

Having cash available is perhaps the most cost-effective option of a buy/sell agreement. However, one major issue is not knowing when or how much money is needed. Having large portions of cash constantly available may lead to opportunity costs of using the money elsewhere, such as further investment in the business. It also may not be a viable option if each owners’ share represents a significant amount of money – especially if more than one owner leaves the business in short succession and there is a shortfall in funds.  

Instalment Payouts

Similar to the cash option above but spreading the payments to the departing owner’s estate over time. This can have a lasting effect on the business, the larger the payments the longer they carry on for. It can put off the buy-out for many years and may not satisfy the wishes of the seller, especially given their ongoing payments rely on the continued success of the business.

Borrowing

This option may be attractive in that there is no outlay by the business until a death or disability occurs. But it relies on a bank agreeing to lend the business money. Then consider the ongoing cost of servicing that loan. If the share is $1,000,000, the interest payments alone could be beyond $50,000 per annum.

Insurance

An adequate level of life insurance would make it possible for the departing owners’ surviving spouse, children or estate to receive the full value of the business interest immediately, without further strain or financial pressure on the business. It can be a cost-effective option to business owners and budgeted for easily, simply being viewed as a cost of doing business. Insurance premiums are an outlay, potentially without financial benefit, but certainly offset by the peace of mind it provides.

Many people think that something like this won’t happen to them. But consider that the more business owners you have, the greater your risks are magnified.

Some statistics from Zurich:

• A business with two owners has a 52% chance that one will die or become totally disabled before the age of 65
• A business with three owners sees that risk increase to 67%
• For four owners it’s 77%
• Five, it’s an 84% chance and for a business with six owners, the risk is 89%.

What does that mean for you and your business?

Planning for the unforeseen is easily sidelined with a “it won’t happen to me” mentality. No one ever expects the worst. To exercise some control over the unforeseen is important for your business, your partners and your family.  If you’d like to speak to me about putting a Business Estate Plan in place please get in contact with me.

* Zurich Australia “You never know who you might end up working with… or for!”