SCC Chartered Accountants

Does your business have a will?

There are almost two million small businesses in Australia, employing over three million people.  Very few have made provisions for the loss of a partner of one of the business owners.

Not Many business owners believe they will take over the business if their partners or co-directors retire or leave the business.

Regretfully, most of these businesses never set a contingency plan in the event of an owner being physically unable to work in the business due to illness, injury or death.

A buy-sell agreement may be thought of as a sort of "premarital agreement" between business partners/shareholders. It is sometimes called a 'business will'. An insured buy-sell agreement (agreement funded with life insurance on the participating owner's lives) is often the recommended arrangement by business succession specialists, this ensures the buy-sell arrangement is well-funded and also to guarantee there will be money when the buy-sell event is triggered.

Traditional buy-sell agreements have been primarily concerned with the transfer of business equity between owners.

However, it is increasingly common for agreements to also deal with liability issues (debt reduction, guarantor protection and key person insurance). These are usually known as business succession agreements.

Generally the agreement is structured in such a way that it does not matter what business structure has been used to own the business i.e. family trust, company, partnership.

A buy/sell agreement is a contract usually entered into between business partners pursuant to which the surviving partners are bound to buy out the other partner's interest in the business should a specific event occur. Specific events which may trigger a buy/sell agreement include death, divorce, long-term disability, retirement or bankruptcy.

Buy-sell agreements are often linked to an insurance policy on each partner's life as this provides the surviving partners with the money to be able to buy out the deceased/disabled/departing partner's interest.

Once life insurance is accepted as the funding medium, it is vital for the owners to enter into a written agreement, setting out what they are to do with their respective interests.

The most important issues surrounding the insurance policies that underpin a buy-sell agreement are: valuation of the business (and of each owner’s share); policy ownership and taxation issues (with regard to premiums, proceeds and transfer of ownership); and the buy-sell agreement itself.

In the sale of a business, a buy-sell clause (or Shotgun clause) in a agreement preserves continuity of ownership in the business and ensures that everyone is fairly treated, the buyer as well as the seller. It is a binding contract between business partners or shareholders about the future ownership of the business.

A buy-sell agreement is made up of several legally binding clauses in a business partnership or operating agreement (or it can be a separate agreement that stands on its own) that can control the following business decisions:

• Who can buy a departing partner's or shareholder's share of the business (this may include outsiders or be limited to other partners/shareholders);
• What events will trigger a buyout, and; (the most comment events that trigger a buyout are: death, disability, retirement, or an owner leaving the company)
• What price will be paid for a partner's or shareholder's interest in the partnership and so on.