Business Succession Plan

A business succession plan is a documented, commercial, financial and legal strategy designed to enable the orderly change of ownership or control of a business upon the occurrence of certain trigger events.

The business owners enter into what is referred to as a “Buy-Sell Agreement” before an event occurs at a time when all parties are on an even footing. The Buy-Sell Agreement facilitates an orderly transfer of the departing owner’s interest in the business in a way that can be funded by the remaining owners.

Advised Life (in conjunction with our legal advisers Andreyev Lawyers) can assist business owners in structuring a business succession plan.

There are four (4) key issues that need to be addressed when putting into place a Buy-Sell Agreement.

1. Trigger events

Which events will trigger the Buy-Sell Agreement?

These trigger events are often referred to as the “7 D’s” and can be categorised into two groups. “Uncontrolled” and “Controlled” events.

“Uncontrolled” events occur without a Principal taking any deliberate action, they include:

  • Death
  • Disability (including prolonged sickness and trauma)
  • Divorce and
  • Default (including Bankruptcy or a failure by a Principal to adhere to the agreed terms on which the enterprise is to operate.)

“Controlled events” are within the deliberate control of one or more of the Principals and include:

  • Departure (retirement, resignation, etc)
  • Disagreement (resulting in a permanent failure in the relationship between the Principals); and
  • Deadlock (meaning that one or more key decisions cannot be made by the Principals)

2. What will happen when the event occurs?

Will the business interest be transferred, or will there be a granting of an ‘option’ over the business interest?

3. How will the business interest be valued?

Will there be a fixed value placed on the business or will a pre-determined agreed method be used to value the business in the case of a trigger event occurring?

4. How will the buy-out be funded?

In the event of death or disability, insurances can be put into place as long as the business owners are insurable. If this is not possible then personal funds of the continuing owners or ‘vendor finance’ terms may need to be agreed upon to fund the buy-out.

A Case Study

Two friends, Mark and Paul, become partners in business.  They are shareholders of ABC Electrical Pty Ltd which is worth $1m. Each owns an equal 50% share worth $500k. Business is growing and is the primary source of income for both them and their families.

Things are going well, but they have not had time to consider any consequences to the business if one were to die, become ill or disabled.

Sadly, Mark is involved in a car accident and dies.  Mark and Paul have no agreement or insurances to provide for what happens to the shares and how the business will continue to trade.

Mark’s shares are now owned by his Legal Personal Representative (his wife Linda) for his beneficiaries. The Executor has a legal obligation to administer the estate by collecting, selling and distributing his assets. Mark’s Executor has no need to consider the financial well-being of Paul or ABC Electrical Pty Ltd. The Executor also has the right to receive full dividend distributions though they do not contribute to daily operations or profits.

With Mark no longer working, the business starts losing money and Paul can’t afford to hire a replacement. Paul wants to carry on the business without Linda’s input, whom he never really liked, and without having to share profits.

Linda decides she doesn’t want to be in business with Paul and wants the money for Mark’s share of the business.

There is a dispute about the value of the business as Linda believes the business is worth $1.5m and feels that she should receive $750k for Mark’s share.

Paul believes that the company is still only worth $1m and that Linda is only entitled to receive $500k.

Linda decides to take Paul to court as they can’t come to an agreement and the business ends up folding.

How could a Buy-Sell Agreement and Insurance have solved the problem?

If Mark and Paul had an agreement in place and life insurances, there would have been life insurance proceeds available to pay Linda for Mark’s share of the business upon his premature death and a method of transferring Mark’s interest in the business back to Paul.

There would have been a legal agreement in place as to how the business would be valued which would have prevented Linda taking Paul to court over the value discrepancy.

It could also have covered the terms under which shares are to be transferred (right of first refusal, priority purchase rights and restrictions on who can purchase) as well as Dispute Resolution clauses.