Developing a well integrated business succession plan is vital to ensuring the effective succession of your business, following a trauma event, disablement or death. With recent events in the world, you just never know what is around the corner.
Take the following scenario.
Bill and John are business partners and each own 50% each of a manufacturing business (operated through a private company). The business, and their families, are thrown into disarray at the unexpected death of Bill.
Business outcome: without an adequate succession plan
Bill’s share of the business would be left to his wife, Susan. John would continue to run the business on his own and contribute 100% to the running of the business, but will only receive 50% of the profits. Susan has never been involved in the running of the business, John and Susan would now be business partners and John would need to get Susan’s consent on business decisions. In addition, Susan is now no longer receiving John’s salary and nor does she receive any lump sum inheritance on his passing, to provide for her future.
John would have been happy to pay her out IF:
- he knew what the business was worth;
- Susan would agree to the value (and wanted to sell); and
- he had the funds to buy her out.
Business outcome: with an adequate succession plan
Backed by a buy sell agreement, John is able to buy Bill’s share of the business from his Estate. John gains full control of the business. Susan, as beneficiary of Bill’s estate, receives the full value of Bill’s share in the business.
Key components to an adequate business succession plan
- a shareholders agreement determines what will happen to a business owners share of the business upon their death or disability
- a buy/sell funding agreement determines how the money to buy the departing owner’s share will be provided.
An effective business succession plan is about having the right amount of funds from the right source pass to the right party(ies) at the right time
An effective business succession plan is about having the right amount of funds from the right source pass to the right party(ies) at the right time, when a business equity partner dies, or becomes totally and permanently disabled, or suffers a trauma warranting a mutually agreed departure from the business.
What about tax?
Tax consequences of business succession can be significant and are often overlooked in the implementation of business succession plans.
- A properly prepared plan ensures that only nominal stamp duty is payable when you sign the Business Succession Plan. With poor drafting, stamp duty may be payable on the buy-sell agreement itself as well as on the actual transfer of ownership interests.
- Capital Gains Tax (CGT) can be triggered on the 'disposal' of the business. There are avenues available to ensure the assets are transferred without triggering CGT provided you plan upfront. Poor drafting can lead to a mandatory agreement being entered into rather than an option agreement. A mandatory agreement transfers a business owners interests immediately upon the occurrence of an option event with respect to a business owner. This can lead to severe tax consequences with the date the buy-sell was entered into being deemed as the date that a disposal of ownership interest occurs for CGT purposes. This would result in a requirement to amend a prior tax return in order to include any capital gain made on the disposal of their ownership interests. Interest and penalties may also be imposed by the ATO.
What if I am a sole owner of my business?
Business Succession Planning still applies to you and is just as important (and sometimes more) when you are the only business owner. If you are sole directors of a Company and something happens, then if poorly planned this could result in the freeezing of valuable assets and cashflow of the deceased’s family. Your plan may include key employees or other stakeholders inthe business and as a minimum would include a funding agreement and tax considerations that would arise on your death.
How do I create a Business Succession Plan?
We are here to help along with your lawyer. We are a team along with yourself/ves. Your Accountant, Financial Adviser and Estate Planning Specialist must work together to create a holistic Business Succession Plan. It is not about buying a life insurance policy, preparing a will, or outlining your wishes in your business plan. Contact Colin Samuel or your Prosperity Adviser to discuss further how Business Succession Planning applies to you.
