In this Solution in Action, we take a look at Buy/Sell Agreements between arm's length owners of a Business. Those in private business need to always have one eye on succession planning and making sure their family receives fair value for their share of the business on their departure.
Succession planning will enable your clients to preserve the value of their stake in their business so it can be properly dealt with for the benefit of their family.
It will provide:
Guidelines for the continuing control and ownership of the business when your client ceases to be an owner of the business;
Stability for the ongoing business partners to carry on operating the business after your client exits.
Exit from the business can be accomplished with a minimum of cost and complication if a succession plan has been properly considered and implemented.
SCENARIO
John Forester and Paul Johnstone have been working in partnership in their consulting practice for more than twenty years. John recently suffered a heart attack and was advised to stop working before the stress took his life.
Paul wished to continue with the business but was concerned about how to buy out John’s share of the business. They had never made any formal agreement about the terms and conditions of departure from the business and problems quickly arose between them, while they tried to find the right solution.
There are many examples of businesses that have been paralysed by the untimely departure of a key person in the business. Where that departure was at least considered, and a plan put in place to cope with those events, there is far less likelihood of failure of the business or wastage of its value.
SOLUTION
No matter how complex the business or how simple the project, there should always be some definitive rules, terms and conditions in a succession plan. These provisions and terms are usually set out in a Buy/Sell Agreement. Similar agreements include Governance Agreements, Partnership Agreements, Shareholder Agreements, Unitholder Agreements, etc.
BUY/SELL AGREEMENTS - THE BASIC INGREDIENTS:
Trigger events - situations that trigger the entry or exit of an equity holder (death, disability, divorce, retirement, misconduct, and purchase proposal/offer).
Value - the value of the business or other assets. Value can be determined (for example) by agreement (fixed or formula), linked to proceeds of an insurance policy, expert determination, price offered by arm’s length purchaser, or restraint of trade.
Payment - how each equity holder receives payment for their share on departure. Depending on the trigger event, funding options include payment on terms (delayed, instalments or security), insurance, and retirement funding provisions.
Dispute Resolution - provisions to encourage the operation of common sense over protracted litigation (mediation, expert determination, guillotine, or deadlock clauses).
BUY/SELL AGREEMENTS - CGT
In most situations, the drafting of the Buy/Sell Agreement will include the use of “Put and Call Options”. For tax purposes, the execution of an agreement containing “Put and Call Options” will not trigger a CGT liability until the options are exercised and a binding Sale Agreement comes into effect.
A call option allows the remaining equity holders to call on the family of the deceased party to sell, and enforce that obligation, if required.
A put option allows the family of the deceased party to require the ongoing business partners to buy them out.
FUNDING USING LIFE INSURANCE
Properly structured, the proceeds from life insurance policies used to fund the exit of an owner from a business on death or disability ought to be received free of tax.
RELATED ESTATE PLANNING STRATEGIES
A Buy/Sell Agreement should be accompanied by an appropriately structured Will incorporating Testamentary Trusts.
SUMMARY
Adequate succession planning should deliver certainty for a business owner’s family and business partners on their departure from the business. With certainty usually comes stability for the business.
Planning for business succession will usually save significant taxes and stamp duty, and minimise professional fees on the departure of a business partner.
CONTACT
Please contact one of our specialist solicitors to discuss asset protection, estate planning or trusts in general, or your specific cases.
Your clients are welcome to attend an initial personal consultation, at no charge or obligation, with one of our specialist solicitors, to discuss their individual circumstances.
Ph: 07 3230 5222
Fax: 07 3252 1355
Email: clearlaw@clearyhoare.com.au