Advivo’s Managing Director, Leon Stephan, explains when you should consider a buy-sell agreement for your business.
We often talk about how best to structure your business. The complexity of your structure will vary depending on many issues, and one of the most important is the diversity of ownership – be it partners, shareholders or unit holders under the structure you and your advisors have chosen.
If your business ownership is a more diverse ownership group (beyond you and your spouse/life partner), then you should have a partnership/shareholders or unit holders agreement to dictate the way you operate the business and interact with each other. This includes multi-generational family businesses companies and trusts with an external broader ownership group making up the leadership group providing essential skills and client management services necessary for the operation of your business.
We have written blogs before on the absolute necessity for shareholder and similar agreements so I will not re-hash that subject here. Now, I’d rather bring to your attention to what happens when unexpectedly through death, injury or illness a key person is no longer available to perform their duties for the business. You may wonder…
• What is the impact on the business?
• Can the business survive without this person?
• How do we replace them?
• How do we deal with their equity in the business?
• If the existing equity ownership remains unaltered save for moving to an estate or its beneficiaries how do I attract the new skills of the right level into the business if we can not offer equity?
• Can the business continue uninterrupted while these arrangements get sorted out if it is a protracted process involving estate finalisation?
• Will the business now have to negotiate some form of agreement and sale of equity with the estate executors?
These are just a few of the challenges that a business could face in the event of the loss of a key person who has equity ownership – all whilst trying to keep the business going as it was in the absence of those skills.
This is why the owners of the business need to have not only a shareholder’s agreement or something similar, but it also needs to be linked to a buy-sell agreement that sets out what happens in the unfortunate demise or incapacitation of a key equity holder, and how the business will get back on track ASAP.
The buy-sell agreement sets out the terms of what needs to be done in these unfortunate circumstances, and is generally underwritten by a life insurance policy owned by the business that will be actioned quickly without involving personal estate matters and can keep the business moving forward by funding the following:
• Recruitment costs
• Temporary contractors/employees
• Payout of exiting owners’ equity
The payout is often vitally important to solve long-term and often messy involvement with an estate (Does the remaining business owner really want to be in business with the spouse of their former partner who has limited knowledge and skills to add to the business?) This makes an attractive way to introduce a new equity into the business in replacement.
In short, any business with diversified ownership needs a partnership/shareholders/unitholders agreement coupled with a buy/sell agreement underwritten with an appropriate level of insurance to ensure that the loss of a key person and their skills and contacts will not adversely affect the sustainability of the business.
