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“SOBERING FACTS: The majority of small businesses fail to update their buy-sell agreements on a regular basis, particularly as the business grows and the value of each partner’s share changes. One infamous case was where two ladies put $52,000 each into a start up recruitment business and the buy-sell agreement reflected that amount. Unfortunately, 5 years later one of the partners died. At this time the business was then worth $13million, but the buy-sell agreement said the remaining partner only had to pay the deceased’s estate $52,000 for her half of the business. This left the deceased’s family in financial ruin, but nothing could be done.
Life, Total & Permanent Disability (TPD) and Trauma Insurance can all help to provide the funds needed to payout the deceased estate. But regular reviews of the value of the business and adjusting the sum insured on these policies to allow for the share transfer will ensure two things: 1. The deceased’s (or disabled) family is provided for financially without the concern of running a business; and 2. The remaining partners retain control of the business and do not need to adversely affect the business financially by borrowing or selling assets at a time when the business may be suffering financially due to the loss of that partner.”
DP Wealth Protection has a clear focus when addressing the protection needs of any business:
- Revenue Protection;
- Asset Protection; and
- Ownership Protection.
The key to good, effective protection is to ensure the right amount of money, from the right source, passes to the right party(ies), at the right time when a business equity partner dies or becomes totally disabled or suffers a trauma, warranting a mutually agreed, but unexpected departure from the business. Get anyone of these “rights” wrong and the plan will fail.
What are the options:
- Borrow – this will mean paying back $ for $ plus interest. And what if due to the partner’s exit, the business is devalued and unable to borrow the funds needed?
- New Partner – ask yourself, who would it be? How much would it cost to find and hire them? How will the shift in control affect the business? There is downtime costs associated with this approach as well.
- Sell Personal Assets – Wouldn’t this approach jeopardise your and your family’s lifestyle, not to mention put relationships at risk? The cost is $ for $ plus capital gains tax (CGT) on some assets and not all assets are liquid which delays the availability of the funds. What is the cost to your lifestyle?
- Sell Business Assets – By selling business assets, you devalue the business, potentially lose the ability to generate some revenue and diminish resources within the business. Again, you would need to find $ for $ plus CGT and the opportunity cost could be significant.
- Liquidate – What if the business is not worth what it was yesterday? What do the surviving partners want? How long will the business take to sell and will the funds adequately compensate all parties?
- Vender Finance – The deceased’s estate wants certainty and needs cash now, not some time in the future. This also restricts the cashflow of the business.
- Deal with Estate – Estate wants continued dividends in a company that may be wanting to reinvest to compensate for the lost partner and/or growth. This creates conflict and stresses relationships. Control has also been diluted for the remaining partners. If the conflict results in a court battle, the costs are significant both monetary and emotionally.
- Insurance - If you choose insurance to fund the transfer of ownership, protect revenue or pay out business debts, you pay a premium each year for the entitlement to the full sum insured. That means the cost to fund any of the above is a % of the $ and swift payment of the entitlements ensures all parties receive the money when needed most.
Consideration around who owns the insurance policies is important from both a functionality and tax implication point of view.
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