When starting a business the last thing that many new business owners give consideration to, or sufficient consideration to, is what will happen in the future when the new business owner or an existing joint business owner either wants to exit the business or, through death, illness or disablement, is forced to exit the business.
A recent Succession Report prepared by Pitcher Partners in conjunction with Swinburne University revealed that 51% of business owners do not have a business succession plan in place.
An important part of any business succession planning is putting in place as early as possible an agreement between the business owners setting out an agreed process for what is to happen when one of the business owners wishes (or is forced) to exit the business and, importantly, what is to happen to that business owner’s interests in the business.
Can’t I give my interest in a business to someone else in my Will?
Business owners are in many instances able to bequeath or gift their business interests to someone of their choice under a Will.
However, this method of business succession has a number of pitfalls, the most significant of which is that it may well leave the surviving business owners in a business arrangement with a person or persons with whom they are not familiar and with whom they may not wish to have an ongoing business relationship.
For this reason it is important for businesses to have an agreed business succession plan in place. A commonly used way of achieving this is through the use of a Buy/Sell Agreement.
A Buy/Sell Agreement will take precedence over the Will because the deceased’s business interests will be transferred in accordance with the Buy/Sell Agreement and will not form part of the deceased’s estate.
What is a Buy/Sell Agreement?
A Buy/Sell Agreement is in effect part of a business succession plan. It is a contract that provides for the future payout or sale of a business owner’s interests to his or her business partner(s) on the happening of certain events. Typically these events include such things as the disablement or death of one of the business owners. A Buy/Sell Agreement will also often set out an agreed mechanism for the succession of one business owner’s interest in the business to the remaining owners of the business or to a third party.
Buy/Sell Agreements are also frequently linked to insurance policies which are put in place where a trigger event will (or is likely to) have a significant financial impact on the business.
If you own a business and you’re concerned about how the death, disablement or retirement of one of your business partners may have on the operation of your business, then a Buy/Sell Agreement can assist you. Not only does it allow you to purchase your business partner’s share if any of these things trigger events were to happen, but it can also help you avoid your ex-business partner’s spouse or children moving into your business.
However, business owners must seek competent accounting advice in relation to any capital gains tax implications before entering into a Buy/Sell Agreement.
Are all Buy/Sell Agreements the same?
Standard-form legal documents written with generic terms and conditions often do not take into account the particular circumstances in a given case and therefore risk being ineffective in the particular circumstances and are often unclear and confusing.
In particular, the risk with standard-form Buy/Sell Agreements is that the document:
1.will not be prepared for your particular business with all of its unique circumstances and your specific needs; and
- may in the end be found to be legally unenforceable making the whole exercise a waste of time and money.
Therefore, it is advisable, and makes commercial sense, to have a Buy/Sell Agreement prepared specifically for your personal and business circumstances by a lawyer experienced in preparing such documents.
What are the main advantages of having a Buy/Sell Agreement?
- provide certainty for the business owners by reducing the risk of succession disputes;
- reduce the risk of the transfer of an outgoing owner’s interest in the business being undervalued with devastating financial consequences;
- reduce the risk of the business suffering significant financial loss , or even having to be wound up, because no agreed mechanism is in place to deal with business succession thereby resulting in all the business owners suffering financial harm.
There are many good reasons to have a current business succession plan in place for your business and to include a carefully and properly prepared Buy/Sell Agreement as part of that business succession plan.