Shareholder Insurance -

Business Succession Planning

What is Business Succession planning?

Business succession refers to planning how a business will be managed in the event of death, illness, injury, retirement or departure of one of its owners.


Why is a business succession plan needed?

Where a business is owned by two or more people, the death or permanent disablement of one owner can create financial hardship for the other owner(s).


A sound business succession plan is important. If business owners have not implemented plans to safeguard their business, the result may be:


  • • the continuing owner(s) may not be able to afford to buy out the outgoing owner’s share of the business,

  • the outgoing owner’s family may receive less than the market value for his/her share of the business,

  • in the case of death, the estate may insist on immediate and direct involvement in the control and operation of the business, but may not have the expertise to handle this

  • in the case of death, the estate of the deceased business owner may be forced by circumstances to sell his or her interest in the business to an outside buyer at fire sale values

  • in the case of traumatic illness (eg. heart attack), there may be uncertainty over the likelihood of the business owner recovering or ever returning to work

  • the continuing business owners may end up doing all of the work, but splitting the profits with a nonworking owner, or

  • the business may no longer be viable and be forced to wind up.


The lack of proper agreements can make negotiations to buy-out or continue running the business difficult. For example:


  • Partnerships – under partnership law, the partnership is automatically dissolved upon the death of a partner. The business can only continue if the deceased partner’s beneficiaries agree, otherwise the business needs to be liquidated.

  • Company ownership – the company continues to exist after the death of a shareholder. However, disputes can arise around the distribution of company profits with both active and inactive owners.

  • Gives peace of mind to the continuing business owners so that they can buy out the departing business owner’s share of the business without putting the business or their personal finances in jeopardy.


When a business has more than one owner, business succession planning is usually essential. The death, injury or disablement of a co-owner can cause severe problems for a business and can throw ownership into disarray. All the years and hard work in building a business can be lost if provision for succession is not planned. The interests of the deceased’s family or beneficiaries also need to be taken into consideration. The family may need funds urgently, and will want to realise the true value of their interest in the business. The beneficiaries of the deceased may also want to become involved in the business, and this could be a problem for the remaining owners.


A business succession plan addresses the needs of business owners and the beneficiaries/family of a deceased or disabled owner, and allows the ownership of the business to remain consistent with the wishes of the owners. Because there are a number of ways in which business succession can be implemented, and these can have serious tax as well as other financial implications, business owners should seek professional financial advice before embarking on any particular strategy.


If a business owner leaves and it is decided by the remaining business owners to continue the business, the departing owner may:


  • transfer their business share to the remaining owners/partners

  • sell their business share to a third party, or

  • transfer their business share to their family member(s).


Succession planning can help a business owner(s) to:


  • improve the value of the business

  • provide an exit strategy

  • safeguard business continuity into the future

  • pass on the business to next generation, and

  • provide peace of mind and certainty to co-owners/ successors.


By putting a formal business succession plan in place, business owners can exit on their own terms and plan that they or their estate receives the full value of their share of the business.


What type of succession plan do I need (buy/sell agreement)?


The structure of the business (eg. sole trader, partnership or company), potential buyers (eg. co-owners, third parties) and the level of debt, will determine the type of succession plan needed. Business succession planning requires a solicitor to draft the most appropriate method of passing the business interest to the party or parties in the form of a buy/sell agreement.


A buy/sell agreement is also generally used to determine how the change of ownership will be funded.


Example: business succession plan in practice Martin and Sarah are partners in a small, successful dental practice. Martin and Sarah had prepared a business succession plan, and had agreed that the business was valued at $2 million. James suffers a fatal heart attack. He is survived by his wife, Jane and two young children. Martin and Sarah had taken out life insurance to fund the purchase of each other’s share of the business in the event of one of their deaths. When Martin died, Sarah was able to pay the $1 million from life insurance proceeds to Jane, representing Martin’s share of the business. This meant that Sarah was able to continue the business and Martin’s wife Jane and the children were provided for.


Generally business succession planning has two key components:


  • the transfer (buy/sell) agreement, and

  • the funding mechanism.


The transfer (buy/sell) agreement A buy/sell agreement is a written contractual agreement outlining how a business owner’s interest is dealt with if a trigger event occurs, eg. they die, become disabled, suffer a trauma or want to resign or retire. If one owner suffers a trigger event, the buy/sell agreement operates to transfer ownership of that person’s business interest to the other owner(s) at an agreed price (usually market value). This can have the benefit of minimising disputes and/or interference in the business by the deceased’s family or beneficiaries.


A buy/sell agreement can provide a business owner(s) with a structured timetable for exit to allow:


  • the purchase of the departing owner’s interest in the business, and

  • transfer of that interest to the continuing owner(s).


If insurance is used, the proceeds flow to the policy owner or beneficiary. However this may not be the entity that should ultimately receive the money. Since the departing owner of the business share requires compensation for their business share and any CGT liability, it is imperative that the buy/sell agreement is constructed so that they are the ultimate recipient of insurance proceeds (or other funding).


A buy/sell agreement is still required when the insurance proceeds are owned by the person who ultimately should receive the insurance proceeds. The buy/sell agreement would simply effect the transfer of the business share.


How to establish a buy/sell agreement


A solicitor must be briefed to prepare the buy/sell agreement. The agreement will reflect the particular ownership structure of the business, the funding mechanism to transfer the business share and the trigger events, valuation of the business and the obligations of each party to the agreement. It is advisable for the parties to the agreement to estimate any capital gains tax and stamp duty that will be incurred upon transfer of the business share to ensure that the funding mechanism is sufficient. Something to note: buy/sell agreements should include methodology to determine the value of the business.


Regular review of buy/sell agreements It is important to regularly review the buy/sell agreement to ensure that:


  • the business valuation accurately reflects the true current value of the business as the business value may change over time

  • the insurance policies are updated in line with the business valuation so that the business owners have sufficient funding to buy out the departing owner’s share of the business.


Example: buy/sell agreement – estate as beneficiary Rachel and Crissy are co-owners in a newsagency. If Crissy was to die suddenly, Crissy’s husband Mark, would automatically inherit half the business. Mark is not interested in running the newsagency and dislikes Rachel. However, Rachel has no choice but to allow Mark to become a co-owner of the business. If a business plan was in place and Rachel and Crissy had entered into a buy/sell agreement the outcome would have been quite different. Under a buy/sell agreement Rachel would have to buy Crissy’s interest in the business in the event of Crissy’s death. The funding is provided by the proceeds of a life insurance policy held on Crissy’s life. Following purchase of Crissy’s interest, Rachel becomes the sole owner of the newsagency. The proceeds of the policy are paid to Crissy’s estate under the terms of the buy/sell agreement. The business plan has allowed Rachel to continue the business and Crissy’s estate receives cash for Crissy’s share of the business.


What are Trigger Events?


Business owners will need to decide what trigger events they want to include in a buy/sell agreement. Life insurance can be used to fund the transfer upon death, total and permanent disability and critical illness (trauma) however, it cannot cover retirement or leaving the business for personal reasons. The remaining owners may need to fund the latter options using borrowings, personal assets, gradual buy-out or savings plans. Critical illness creates some additional complications because in many cases the person may not need or want to leave the business.


To cope with these situations, the buy/sell agreement could include a condition that the transfer cannot be triggered unless the person has been unable to work for a set period (eg. six months) or once turnover has dropped by say 20%.


Types of buy/sell agreements


Two types of contracts are commonly used to effect the transfer of shares in a business, the mandatory contract and the contract formed by the exercise of an option.


Contracts formed by the exercise of an option will effect a transfer if either party wishes to proceed. Therefore the transfer of the business does not have to occur if both parties choose not to proceed. Hence the CGT event is deemed to occur at the time of the trigger event. However, a mandatory agreement must proceed (even if both parties no longer want to) and the CGT event is deemed to occur at the time of signing the contract. Clearly this is a most undesirable outcome and one to be avoided.


Mandatory agreements now use ‘conditions precedent’ to trigger mandatory obligations so that the formation of the contract, and hence the acquisition and disposal, for tax purposes is only triggered by a future event. To overcome the exposure of both parties to an unintended acquisition and disposal from a tax perspective a buy and sell contract initiated by the use of ‘put’ and ‘call’ options has come into use.


The ‘condition precedent’ that forms the contract is triggered by the exercise of a ‘put’ or ‘call’ option. By exercising the call option, continuing owner(s) can force the outgoing owner (or estate/beneficiaries) to sell his/her interest in the business at the agreed purchase price. Similarly, by exercising the ‘put’ option, the outgoing business owner (or estate/beneficiaries) can force the continuing business owner(s) to purchase his/her share of the business at the agreed purchase price. planning the acquisition and disposal for capital gains tax purposes takes place upon the exercise of either option. A put and call option agreement requires each party to be aware of its rights because without the exercise of these rights within the appropriate timeframes or in the correct circumstances a transfer of the business share cannot take place


How can Two Mile Bay help?

Two Mile Bay can assist your business in calculating and obtaining the right level of insurance to fund your buy/sell agreement. We have access to 12 insurers and can offer comprehensive advice in this field.


Call today for a complimentary appointment (03) 52 615 557.