ARTICLES

BUSINESS SUCCESSION PLANNING

Protecting the “Jewel in the Crown”
For many business owners, the equity in their business is probably the largest single asset in their personal investment portfolio or estate. It is the "Jewel in the Crown". Yet too few business owners protect this valuable asset from the sudden death, trauma or permanent disability of any of the business partners (including themselves). The consequences of not having a succession, or exit plan for a business partner, should such an event arise, can be disastrous. In the next 30 seconds ask yourself the following questions:

“If I were to become permanently disabled or deceased tomorrow, do I have a buyer for my business? Would I, or my estate, be paid full value for my business? What would it be worth, and could the buyer afford the purchase?”
 
The response to these questions can be quite confronting - scary actually! The thought of having to sell your business in short notice is stressful enough, let alone having to negotiate price and terms whilst incapacitated, or just as untenable, to pass the burden on to the executor of your estate. Yet with some simple planning, a lot of these risks can be eliminated leaving you free to continue growing your business.
 
Business Succession Planning – Identifying the Need
For most business people, equity in their business is probably the largest asset in their personal investment portfolio or estate. This happens for a number of reasons:

1. Most business people minimise salaries or dividends payable to themselves in order to grow the business;
   
   
2. If they make higher payments then additional tax is usually payable and
   
   
3. If profit is distributed out of the business and the business requires additional working capital, it may have to be financed in order to maintain the growth.

As a result, business people tend to leave their wealth in their business. In a sense making them asset rich, cash poor. Business people also tend to ignore the value of their business when they make financial plans for their future. As a result they rarely consider how to obtain the benefit of their equity investment in the business at the time of death, disablement or traumatisation. Without the appropriate level of planning and insurance, the following untenable situations can arise:

1. A business partner dies suddenly and their estate becomes part owner, leaving the remaining business partners to deal with, for example, a non-working spouse;
   
   
2. A business partner dies and the estate wants what they believe to be full value for their deceased spouse’s share of the business. As there are no funds available for this event, a messy “fire-sale” of assets takes place, resulting in the remaining partners having to borrow the balance of funds personally.
   
   
3. A business partner becomes disabled and can no longer contribute to the profitability of the company but has no other source of income. The existing business owners are sympathetic but do not have the resources to buy-out the disabled partner nor continue to pay the partner a salary without him producing income for the business.

As you can see, the overwhelming need is to protect the “Jewel in the Crown”. The one asset that you have spent years building up, but have not necessarily protected from unforeseen events.

How does the Business Succession Plan Work?
The business succession plan provides a mechanism for business partners to realise the full value of their individual equity holdings in the event of death, permanent disability or traumatisation. At the same time the plan provides shareholder funding and for the legal transfer of equity from the deceased or disabled to their remaining business partners (known as a buy/sell agreement).

A life insurance contract on each business partner in essence provides the funds to “buy-out” the equity from the deceased or disabled partner. The life insurance proceeds will end up in the hands of either the deceased’s estate or life insured based on the insurance event. The succession is complete with the legal transfer of equity from the deceased or disabled to the remaining business partners at a pre-agreed value.

What sets this business succession strategy apart is that it incorporates the two key components of a business succession plan, the use of an insurance trust structure in conjunction with a buy/sell agreement.

Insurance Trust
The life insurance of each partner is held in the name of a trust with the life insured as the beneficial owner. The list of key benefits an insurance trust brings with the business succession plan can be seen below:

• Capital Gains Tax (CGT) Exemption
  The use of a trust to legally own the life insurance is in essence a form of self-ownership. This allows the life insured to take advantage of the capital gains tax exemptions for death, TPD and trauma (not available under potential forms of cross and business ownership). Which means the receipt of the insurance proceeds will be free from CGT.
  
  
• Single Policy Multiple Purposes
  The structure allows the business partner to combine personal and business insurance needs on the one life insurance policy. The business insurance needs can extend past the value of equity and can be used to cover director’s loans, hire purchase liabilities, business guarantees, and key-man insurance. The personal need for cover can be just as extensive; mortgage, investment loans, income streams to dependants.
  
  
• Forward Underwriting
  The structure allows for what is known as forward underwriting. This is where the business owner can “slice and dice” the components of insurance cover between business and personal needs without necessarily increasing the insurance policy. This is not available under direct policy ownership.
  
  
• Full Costing of Sale
  The structure has a simple checklist which allows you to fully cost the sale transaction including the CGT, stamp duty, legal, accounting and other adviser costs on the share transfer. Again this can be included in the insurance cover so the true cost is the annual premium.
  
  
• Incoming/Outgoing Partners
  The trust structure allows for incoming and outgoing partners without impacting the existing business partner’s insurance arrangement. Under a cross ownership structure adding a third partner to the original policy is a CGT event. This is avoided under the trust structure.
  
  
• Retiring Partners
  The trust structure allows for retiring partners to “take” their life insurance policies with them at a time when medically re-writing them may result in much higher rates and a greater chance of a “loading” to the premium.

Buy/Sell Agreement
The buy/sell agreement is a legal document which can be included inside or outside the will. In a lot of cases the document is maintained outside the will. This allows the business succession plan to become active in the event of permanent disability and or trauma (not just death). The buy/sell agreement is an important document which caters for the legal transfer of equity, either from a deceased estate or injured party to the remaining partners, or identified purchaser.

The “buy” refers to the purchaser having the option to buy the remaining shares in the business and the “sell” referring to the estate or injured party having the option to sell the shares to the buyer.

Without the buy/sell agreement in place the insurance event may take place with an estate or injured party receiving proceeds for the sale of a business yet have no legal obligation to transfer the equity.

On completion of the business succession plan process, the business has a structure in place which provides a set of rules and timeframe around what is to happen in the event a partner or owner suffers a major insurance event. Business continuity is maintained, goodwill is maintained (or the remaining partners compensated) and the life insured is looked after.

About the Author
Andrew P Jones is a Financial Planner, CPA and Partner of the Sydney based adviser firm Phegan Cook Pty Limited. Andrew specialises in Business Succession Planning and Self Managed Superannuation Funds for business owners and their families, and is licensed through Financial Wisdom Limited (a wholly owned subsidiary of the Commonwealth Bank Group). Andrew can be contacted at Phegan Cook on 02 9460-2288 or email on andrew@phegancook.com.au

DISCLAIMER
This information is of a general nature only and has been prepared without taking into account your particular financial needs, circumstances and objectives and should NOT be construed as financial, taxation or legal advice.

Before acting on this basis of this information, you should consider its appropriateness for your own objectives, financial situation and needs. You should also obtain and read a copy of the relevant Product Disclosure Statement before making any decision to acquire a financial product.

© COPYRIGHT
All articles are copyright. These articles may be used for publication in magazines and newsletters with prior permission from the author and Samperi Consulting Group Pty Ltd. Please contact Samperi Consulting Group Pty Ltd for further information at karina@samperi.com.au.

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