Business Succession Planning
When starting or buying into a business most business owners give little thought about how they might be forced to involuntarily depart the business because of serious illness or accident, serious disagreement with other business owners, to take another opportunity that has arisen or to retire from the business.
While the need for a business to plan for the departure of an owner and to have appropriate legal agreements in place may seem self-evident, a high percentage of businesses do not have any arrangements in place.
Many business owners have worked for years to build up their business and a lot of their wealth can be tied up in the business. The income from the business is often the major or sole income source to support the owner and their family. How will the owner and their family cope if they no longer receive that income or are unable to extract the wealth from the business to generate replacement income?
What is a Buy Sell Agreement and why is there a need?
Sometimes called a “Business Will”, a Buy Sell Agreement is a contract between business owners that provides what is to happen if one of them involuntarily and unexpectedly departs the business.
Usually the agreement gives each owner the option of buying the interest in the business of an owner who dies, suffers a critical illness or major trauma or who becomes totally and permanently disabled. If one of those trigger events occurs to an owner then the other owners can use their option to acquire the business interest (or a designated portion of that interest) of the departing owner. The funding to pay for the transfer of the departing owner’s business interest is usually provided by insurance proceeds from policies that are taken out by each owner for that purpose.
However, where the insurance proceeds have not been increased in step with the value of the business then the continuing owners may be required to cover the shortfall themselves by instalments payable over an agreed period or some other method. While the preferred position will always be to fund the acquisition of a departing owner’s interest via insurance policies, it may not be possible for owners to obtain insurance cover in all cases (e.g. an insurer may decline to cover an owner who has a serious medical condition or illness or who has suffered a serious injury).
Whatever the situation, the consequences of a failure to plan and not having appropriate arrangements in place can be disastrous – the unexpected departure of an owner will result in high emotion or the risk of disputes and is guaranteed to distract the attention of the continuing owners from properly focussing on the operation of the business.
How can other departures from the business be addressed?
When two or more people own a business together they need to ensure that they have arrangements in place that provide what is to happen:
The arrangements that deal with those possibilities can be part of an agreement that also deals with other matters such as the management of the business (e.g. a shareholders agreement, partnership agreement etc.) or they can form a stand-alone agreement that just deals with the departure of an owner for one of the reasons previously mentioned.
Whatever form the arrangements take, they should be agreed and documented while none of the owners are under pressure. This will ensure that each of the owners has equal bargaining power at that time.
Unless there is an agreement that deals with the above possibilities, any of the following are likely to occur:
Agreeing on the necessary arrangements to avoid those consequences is neither prohibitively expensive nor overly difficult. We are able to explain the options and issues to business owners and then, once all necessary information has been reviewed, prepare the relevant agreement for signing.