Buying or Selling a Business

PRE-AMBLE

Business owners who carry on business in a partnership, company or trust arrangement with other co-owners may not appreciate the obligations, legal and otherwise, and the emotional difficulties that can occur when these structures end or because of a principal leaving or dying.

Partnership agreements and shareholder agreements can contain terms dealing with separation, death, or disability; however, in most cases no proper agreement exists to buy-out or sell-out to the remaining partners or shareholders in the event of death, disability, dissolution, or a principal leaving. Let us call these events, possible buy/sell events, or PBSEs.

Partnership and shareholder agreements are not always comprehensive enough to cover all the needs and requirements of relevant ownerships whether it is for individuals, companies, trusts, or unit trusts.

It is quite normal for business operators to use Buy-Sell Agreements to ensure they can effectively transfer ownership of the business in the event of a PBSE. Such agreements should contain formulae and procedures for the buy/sell and the terms of any sale and purchase that arises. However, it is possible that such provisions may be contained in partnership, shareholders or trust agreements. It is then necessary to ensure that the partnership or shareholder or trust agreements work alongside the Buy-Sell Agreement.

The buy/sell agreements also most often have insurances working in tandem with the buy/sell obligations – insurances like life, trauma, and total and permanent disability. These assist in the meeting purchase and termination payment obligations.

If a principal dies or suffers a PBSE the Buy-Sell Agreement provides for the business to pass to the remaining principal/s on pre-arranged terms. These Buy-Sell Agreements provide certainty for dealing with the business assets by setting out those person/s who can or will acquire the interest of the outgoing principal and the price formula for that transaction.

A well-drafted Buy-Sell Agreement can usually give the most tax effective arrangement when that arrangement is implemented.

Where insurance is involved, the tax effectiveness of the outcome can depend on a number of factors including the ownership structure for the insurance. Principals should consider the range of ownership options available, including:

  • Self-ownership;
  • Joint ownership;
  • Entity-business ownership;or
  • Insurance trust

Treating each in turn.

  • Self-Ownership 
    If the life insured owns the policy, his/her estate receives the policy proceeds in exchange for the share of the business being bought/sold. The proceeds are generally tax-free.
    If the agreement does not the transfer the business on this occurrence, clearly the Buy-Sell Agreement is a failure, AND the estate could end up with both the insurance proceeds and the business interest, possibly triggering Capital Gains Tax (CGT).
  • Joint Ownership 
    Joint ownership exists where two or more principals are joint and several owners of the insurance policy. Collection and payment to the deceaseds estate may trigger Capital Gains Taxation event.
  • Business Ownership 
    A business (ie a corporation) can own the insurance policy to buy-back the deceaseds principal’s interest. This is not always beneficial because of possible CGT issues.
  • Trust Ownership 
    Trust ownership of insurance policies can have taxation benefits and flexibility. Under this arrangement, a trust becomes the owner of the insurance policy. If a PBSE occurs the insurer would pay the insurance proceeds to the trust (as owner), with the trustees able to transfer the business share and distribute the funds when necessary.
    The trust may vary the insurance cover if it becomes necessary, and may take new insurance/s if new principals join the business.These insurance trusts have the advantage of being able to streamline insurances by reducing the number of policies required. The policies held by the trust can serve both business succession and personal estate planning purposes, which can then reduce the need for separate policies to address personal and business succession issues. Another possible benefit of trust ownership is the flexibility in making adjustments in the ultimate policy ownerships or benefits as circumstances change.In most other forms of ownership, altering policy ownership or benefits can trigger CGT. These triggers can be usually avoided by using a trust, as it is always the owner of the policy even though the terms or destination of trust distributions may change as allowed by the trust deed.

Whitelaw McDonald can evaluate existing agreements to ensure you have adequate protection from any potential litigation, taxation, and legal costs by implementing a Buy-Sell Agreement.

The Buy-Sell Agreement should cover these obligations:

  • An obligation for a surviving principal or principal’s to purchase an outgoing principals interest in the business for a predetermined agreed value or as established by a method of determination of value;
  • An obligation for the outgoing principal or his/her beneficiaries to sell his/her interest in the business for a predetermined agreed value or as established by a method of determination of value;
  • An obligation to review the Buy-Sell Agreement and business value regularly;
  • An obligation to release any security or guarantee put in place by the exiting principal or their beneficiaries;
  • An obligation to maintain insurance coverage paid if insurance is utilised to fund the agreement;
  • An obligation and formula for a terms payment arrangement if a party utilises that funding medium, including an agreed formula for an interest rate to be paid;
  • An obligation to fix a period for a principal to exit if they suffer from continuing ill health and cannot perform all or most of their essential duties
  • An obligation  to incorporate insurance, terms payment and sinking fund options;
  • An obligation to determine re-allocation of shares, units, or percentages of interest where a principal has exited the business; and
  • An obligation for any entities associated with any party (eg trusts) to comply with the various provisions and obligations.

SUMMARY

The Buy-Sell Agreement is a tool to ensure that the surviving principals in a business and their families are financially secure in the event of death or disability of a principal or in the event of a principal leaving.

Often agreements between shareholders or partners in a business don’t have plans that cover the consequences when one exits the business and how the financial and other considerations for such exit are determined. This has potential for disputes between stakeholders and/or their families such that sometimes the only option is to wind up the business and start again or, worse, having the matter settled by a court. 

Why is it so important?
If something happened to a co-owner of your business to oblige you or, if there is no obligation, to seek to acquire to acquire that co-owners interest in the business without an agreement in place:

  • Would their family and/or estate representatives agree with your position and any offer you might make for a buyout
  • How do you and they determine a value to effect a buyout?
  • Would you want them involved in the business you want to carry on if a buyout position cannot be established?
  • Can you risk the beneficiary of their interests working or interfering in the business?
  • Would you need to borrow money or sell assets to fund the purchase of the interest of that co-owner?

These are just some of the questions to ask.
Unfortunately too many businesses don’t have a formal agreement in place between the business owners.

Other considerations
Structuring the Buy-Sell Agreement and its funding is essential to ensure that the proceeds filter to the right beneficiary. Too often we see business succession plans set up incorrectly which can lead to disaster. At Whitelaw McDonald we manage the process for you, ensuring proper arrangements and valuation determinations are agreed upon and the legal agreement provides what you need when you need it.

Contact us for more information regarding our services.

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