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Where Business Protection equals Family Protection |
| Business Buy/Sell Agreements |
| Business Succession Agreements |
How are you going to maintain your business if your business partner dies or becomes permanently disabled? How are you going to ensure that your family gets paid for your interest in the business if you die or become permanently disabled? |
The surviving or continuing principals in a business may not have readily available funds to buy out the share of a deceased partner or a partner who leaves because of permanent disability. |
The best way to protect yourself against these risks is to have a buy/sell agreement between the principals in a business. The trigger event will be the death, total or permanent disability (TPD) or trauma of a principal. |
Advantages of Buy Sell Agreements and Succession Agreements |
The main advantages of a Buy Sell and Succession Agreements are:
- The surviving principals get the right and the money to buy a deceased principal's interest in the business;
- The surviving principals keep control of the business without interference from a deceased's family;
- A deceased principal's beneficiaries get paid quickly for the deceased's interest in the business.
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| Such agreements provide that when a trigger event (such as death, TPD or trauma) occurs, all the principals have an option to sell their interest to the continuing principals, or to buy out the interest of the deceased or outgoing principal. |
Funding the Sale and Purchase - Life Insurance, TPD or Trauma Insurance |
A common funding method is for insurance cover to be taken on the life or health of the business principals. The most common methods of funding the sale are set out below:
- Self ownership - This is the most common method of funding the sale by the outgoing principal. Each principal owns an insurance policy on his or her own life. On death, the proceeds are paid to the estate of the deceased principal. The insurance proceeds are then deemed to have been paid for transfer of all or part of the deceased's interest in the business.
- Cross ownership - Each business principal holds a policy on the life of other principals. However, this is less useful where there are more than two business principals or where there are changing business principals. This is because capital gains tax may be triggered on transfer of the policies to new principals. Also, when a principal leaves the business then the policy cannot be continued.
- Insurance trust - This method provides for a trustee to own the policies for all the business principals. It is useful where business principals are changing frequently. However, assignment of a policy to a departing business principal might trigger a liability to capital gains tax.
- Superannuation ownership - Superannuation contributions can be paid by a superannuation fund as an insurance premium. This has the advantage that the premiums are deductable to the business. However, issues may arise where a superannuation entity (in particular a self-managed superannuation fund), is used for purposes other than retirement. If it is intended that a particular person is to be paid the life insurance proceeds on death (usually a principal's spouse), there must be a valid binding nomination to ensure that the death benefit goes to that person. Any excess benefit or payments to non-dependants may trigger additional tax liabilities.
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| Why is it called a "Buy Sell Agreement"? |
The buy/sell aspects of the agreement are:
- Each business principal will have a "Buy Option". When a principal dies, the continuing principals have an option to buy the outgoings principal's interest from the estate. The executors of the deceased estate must sell to the co-owners;
- Each business principal will have a "Sell Option". When a principal dies, the deceased principal's estate will have an option to sell the deceased principal's interest to the continuing principal. The co-owners must buy from the deceased estate.
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| This means that when the deceased principal dies, the estate steps into his or her shoes and can use its Sell Option to force the ongoing principals to sell to the estate. The executor will be legally bound by the Buy Sell Agreement signed by the deceased. |
Valuation |
One of the big issues is how to value the business. You could:
- fix a business value that is reviewed regularly;
- agree on a formula (such as one that capitalises profits, such as a multiple of net profit before tax);
- obtain a valuation from the business accountant or by an independent valuer; or
- value the business at book value per the accounts of the business.
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| Family Businesses |
Buy Sell agreements are particularly important in family businesses. Common problems are:
- If a particular child has been involved and interested in a business, a failure to put in place a Buy Sell Agreement may force the family to liquidate the business and distribute the proceeds.
- If the business owner left the business to one child in preference to the others, the estate may become bogged down in litigation if the other children challenge the bequest.
- If the business is left equally to all the children, the chosen beneficiary needs to have the money to buy out their interest.
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| These risks can be ameliorated by taking out life insurance that is paid to the remaining children through the estate to a value equal to the value of the business. This "estate equalisation" enables the other children to take a share in the business and for the involved child to take the business. This gives all the children a fair share and enables the business to continue. |
CGT |
It is important to get tax advice about your business succession strategy. In particular CGT liability may arise. As a general rule CGT will not be payable on payment of a life insurance policy if the gain or loss is made by:
- The original owner of the policy;
- An entity that acquired the policy for no consideration;
- The trustee of a complying superannuation fund.
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However, CGT liability may arise:
- · If a TPD or trauma policy is owned by the business (that is one reason why it is important that a TPD or trauma policy be owned by the insured);
- · On exercise of the option under the Buy Sell Agreement the sale of business will trigger CGT liability. You should get advice on the small business CGT concessions.
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| Are Premiums deductable? |
| Only insurance premiums that are intended to provide income are deductable for tax purposes. Normally, the premium payable for death is not deductable, but premiums for income for a period of disability are deductable. Death cover can be deductable if an employer owns the policy and is the beneficiary of the policy, if the purpose is to advance the business and if the premium is paid for a revenue purpose. |
Clark McNamara Lawyers has considerable experience in Buy Sell Agreements and Succession Agreements. If you are interested in our "fixed fee" options to draft your Business Succession Agreement please contact Peter McNamara on 9299 2223. |
You may find it useful to complete the Buy Sell Agreement Questionnaire. If you send us a completed Questionnaire we will send you a fee estimate to draft you a Buy Sell Agreement. |
peter.mcnamara@cmlawyers.com.au
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