by Amanda Cassar, AFP®
Have you heard about Contingency Planning but not sure what it’s about?
Basically, it’s protecting assets and owners of your business from liabilities that result from unfortunate circumstances.
It’s easy to overlook financial considerations when running a business. Most business owners make no provision for what will happen when it’s time to retire, they become gravely ill or die. Lack of planning is rarely done on purpose, but often because owners are unsure of where to turn.
Strategies to consider are:
- Business Loan Protection Strategies
- Shareholder / Director / Beneficiary Loan Protection
- Key Person Revenue Protection
- Business Succession Safeguards
What Could Possibly Go Wrong?
Failure to take care of Business Succession Planning may result in undesirable outcomes. Why?
- Your partner or family may not receive full value of your interest
- Your business partners may be left to run the business with your spouse or children who may have no skills
- Lending institutions may call in guarantees
- The business may have difficulty meeting commitments and suffer liquidity issues
- Loss of a key person in your business can cause severe profit loss
- Unforseen illness or injury to a key person does not stop fixed overheads needing to be paid
All events raise interesting questions but often have simple solutions. If these aren’t considered or acted on, it could result in your business’s complete closure. Likely you’ve envisioned something quite different for the business and your family.
A Case Study
Three friends become partners in business. The tradesmen are shareholders of XYZ TRADIES Pty Ltd which is worth $750k. Each owns an equal share of $250k. Business is growing and is the primary source of income for all men and their families.
Things are going well and they have not had time to consider any consequences to the business if one were to die, become ill or disabled.
Sadly, Jase is involved in a car accident and dies. Mark, Jase and Ted have no agreement to provide for what happens to the shares and how the business will continue to trade.
Jase’s shares are now owned by his Legal Personal Representative (his wife) for his beneficiaries. The Executor has a legal obligation to administer the estate by collecting, selling and distributing his assets. Jase’s Executor has no need to consider the financial well-being of Mark, Ted or XYZ TRADIES Pty Ltd. The Executor also has the right to receive full dividend distributions though they do not contribute to daily operations or profits.
With Jase no longer working, the business starts losing money and they can’t afford to hire a replacement. Mark and Ted want to carry on the business without Jase’s meddling wife, whom they never really liked, and without having to share profits.
Jase’s wife wants to sell his interest to a competitor who will pay over market price. Even if Mark and Ted convince her to sell them his shares, they need to fund the purchase from their own sources. This could have been prevented if a Business Succession Plan was in place.
How?
A buy-sell agreement is the cornerstone of any business succession plan. It is a contract that sets out rights and responsibilities of those involved, addresses timing, terms, and funding (usually through insurance) of purchase and sale of shares in the company which owns the business. A good buy-sell agreement should include:
- A mechanism to financially enable remaining shareholders to purchase shares of exiting shareholder
- A predetermined method of valuing shares to be transferred
- Terms under which shares are to be transferred (right of first refusal, priority purchase rights, and restrictions on who can purchase)
- Circumstances to trigger a transfer (death, total disability, trauma, divorce or retirement)
- Dispute resolution clauses
The agreement is an important tool in providing for a planned, orderly transfer of the shares with minimum disruption. A main advantage of a buy-sell agreement is to provide for business continuity, and ensure that ownership of the business remains with individuals elected by the owners.
What you need to do
If you have business partners, all need to agree to ensure the plan is actioned when the time comes.
To develop a succession plan, speak to your accountant, solicitor or planner who can advise on developing a plan that best suits you, your business and family. Often an adviser who specialises in this area will have ties to other professionals who can assist with valuations and agreements.
Amanda Cassar, AFP®
Wealth Planning Partners