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What happens to a company when a key person or owner exits the business due to an illness, disability or death?
Business estate planning, or succession planning, looks at arranging your business affairs should a key person or owner of the business exit. The aim is to avoid any detrimental effect to the continuity, revenue or profit of the business.
When there is no formal plan or agreement in place between owners, it can result in beneficiaries inheriting a controlling interest in the company. The beneficiaries may not have the skill, experience or expertise in playing an active role within the business. They may simply want to sell their share. This can lead to various risks including:
Having a detailed agreement between business owners provides legal certainty if the unforeseen occurs. It provides the remaining owners the right to buy the share of the departing owner, whilst also ensuring that the departing owners estate or beneficiaries are paid an agreed amount as consideration for the shares in the business. The agreement would detail the events that trigger the agreement, such as death and disability, a method of valuing the share of each owner, the buy and sell obligations of the business and the means of funding the buy/sell.
Having cash available is perhaps the most cost-effective option of a buy/sell agreement. However, one major issue is not knowing when or how much money is needed. Having large portions of cash constantly available may lead to opportunity costs of using the money elsewhere, such as further investment in the business. It also may not be a viable option if each owners’ share represents a significant amount of money – especially if more than one owner leaves the business in short succession and there is a shortfall in funds.
Similar to the cash option above but spreading the payments to the departing owner’s estate over time. This can have a lasting effect on the business, the larger the payments the longer they carry on for. It can put off the buy-out for many years and may not satisfy the wishes of the seller, especially given their ongoing payments rely on the continued success of the business.
This option may be attractive in that there is no outlay by the business until a death or disability occurs. But it relies on a bank agreeing to lend the business money. Then consider the ongoing cost of servicing that loan. If the share is $1,000,000, the interest payments alone could be beyond $50,000 per annum.
An adequate level of life insurance would make it possible for the departing owners’ surviving spouse, children or estate to receive the full value of the business interest immediately, without further strain or financial pressure on the business. It can be a cost-effective option to business owners and budgeted for easily, simply being viewed as a cost of doing business. Insurance premiums are an outlay, potentially without financial benefit, but certainly offset by the peace of mind it provides.
Many people think that something like this won’t happen to them. But consider that the more business owners you have, the greater your risks are magnified.
Planning for the unforeseen is easily sidelined with a “it won’t happen to me” mentality. No one ever expects the worst. To exercise some control over the unforeseen is important for your business, your partners and your family. If you’d like to speak to me about putting a Business Estate Plan in place please get in contact with me.
* Zurich Australia “You never know who you might end up working with… or for!”
Hewison Private Wealth is a Melbourne based independent financial planning firm. Our financial advisers are highly qualified wealth managers and specialise in self managed super funds (SMSF), financial planning, retirement planning advice and investment portfolio management. If you would like to speak to a financial adviser on how you can secure your financial future please contact us 03 8548 4800, email info@hewison.com.au or visit www.hewison.com.auPlease note: The advice provided above is general information only and individuals should seek specialised advice from a qualified financial advisor. The views in this blog are those of the individual and may not represent the general opinion of the firm. Please contact Hewison Private Wealth for more information.