Buy sell agreements
Statistics show that less than 30% of businesses have formal succession plans. Even where succession plans exist a startling amount are ineffective as they are not properly structured or formally documented, particularly when it comes to buy sell agreements.
Buy sell agreements play a key role in business succession planning. They are often described as a “business will” as they are a document that allows for the transfer of one business owner’s interest in the business to the remaining owner(s) when a specified trigger event occurs. Some of the trigger events commonly dealt with are death, total and permanent disability and trauma.
The absence of a buy sell agreement can have devastating consequences in the event a business owner is affected by a trigger event. Often their share of the business will be transferred at a significant undervalue because the remaining owner(s) are unable to purchase at market value or, in the worst case scenario, the business may need to be wound up. Other consequences of not having a buy sell agreement can simply be that the remaining owners end up in business with the family of a deceased former co-owner.
The terms of a buy sell agreement will provide that where a trigger event occurs in respect of an owner (“the outgoing owner”) one of the following will occur:
- the outgoing owner or their executor can compel the purchase of their interest by the remaining owner(s); and
- the remaining owner(s) can force the outgoing owner or their executor to sell their interest in the business
Buy sell agreements take precedence over any personal wills made by the business owners because the business will be transferred pursuant to the buy sell contract. Ideally buy sell agreements are fully funded with the purchase price funded by a life insurance policy on the outgoing owner.
Depending on the parties and circumstances, the policies can be held under any of the following arrangements:
- cross ownership, where the owners of the business hold policies on each other;
- principal ownership, where the owner holds the policy on himself/herself;
- discretionary trust, where the trustee holds the policies on behalf of all of the owners;
- company ownership, where the business holds the policies on behalf of all of the owners.
For the outgoing owner(s) the buy sell agreement guarantees sufficient and certain compensation for the transfer of their interest.
For the continuing owners(s) the buy sell agreement provides certainty as to how the outgoing owner(s) will be compensated for their share in the business, without having to provide the funds or finance the buy out themselves. The agreement can even provide opportunity for employees to acquire a stake in the business.
Buy sell agreements are a vital part of succession planning and in the absence of one, can have devastating consequences. If you would like to discuss a buy sell agreement in more detail or your overall succession planning needs please contact Lisa Roberts on (02) 4929 2700.