It is important that every business owner has a succession plan in place to cover what would happen upon their death or another trigger event.
Commonly, if you are in business with someone else this will involve entering into a buy/sell agreement supported by life insurance policies on each partner’s life. The proceeds from the life insurance policy provide the funding to enable your partner(s) to buy the business.
The buy/sell agreement (which should be drafted with the assistance of a solicitor) spells out when one of the owners must leave the business or can choose to leave and how they can expect the business to be valued.
What should you consider in a business succession plan?
When making a plan, you should consider the following:
- What is to happen to the business if you pass away or become disabled - will a family member take over your share or will your share be sold to the remaining partners or will it be liquidated?
- What events should trigger implementation of the agreement – for example, death and/or total and permanent disability? What about other events such as retirement?
- How will the business be valued? What method will be used and will you consult professionals to calculate the value?
- How will the sale of your share of the business to the remaining partners be funded?
What is a buy/sell agreement?
A common way to ensure the smooth transfer of control of a business between partners is to enter into a buy/sell agreement.
The agreement is usually structured so that the remaining partners will purchase the share of the business of the partner who is leaving due to the specified event, such as death or disability. This can be done in a number of ways – through options or by using a conditional contract.
The agreement is usually linked to an insurance policy on the partners’ lives. The proceeds from the policy provides the funding (all or some) to enable the remaining partners to buy the deceased’s interest at the value nominated in the agreement.
The transfer of ownership of the deceased’s interest in the business may result in a Capital Gain or Loss. Currently these are generally tax free in New Zealand. The transfer will be deemed to take place at its market value.
Why should I use a buy/sell agreement?
A buy/sell agreement is a tool to help business partners agree on what might happen in the future and how to best protect all of their interests – both for themselves and their families. It can avoid disputes at a future point in time and provide certainty for planning.
Business owners should discuss their succession plans with each other to ensure they are each comfortable with what will happen to the business and who might take control.
If a buy/sell agreement was not entered into, control of the deceased person’s interest in the business will pass to that person’s beneficiaries. This may cause problems for the surviving partners of the business as well as for the deceased person’s beneficiaries.
Traps in relation to buy/sell agreements
If you enter into a buy/sell agreement, care needs to be taken to ensure:
the agreement is regularly reviewed, checking that it still meets your needs and ensuring the formula or method used to calculate the purchase price of the business correctly reflects the value of the business, and
The life insurance policy is also updated as the business grows so it will provide sufficient money to enable the purchaser to buy the business.
The insured benefit under the life insurance policy might be set at a level to cover the sale of the life insured’s share of the business, but can also be set to provide additional funding to allow debts owned by the business to be repaid.
There are many options for structuring the buy/sell and the insurance policy. The best option will depend on your circumstances and needs.
In developing your business succession plan, the buy/sell agreement and the funding mechanisms, we may need to work with your Solicitor to ensure the most efficient and tax-effective outcome is achieved. It is important that the terms of the buy/sell match the structure of the life insurance policies.
Contact Graig Rhodes to consult further on your needs so we can help you to develop a plan to protect your family and the hard work you have put into your business.
Partner, Nexia New Zealand
t: 03 379 0829