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Understanding the Importance of Business Succession Planning

Understanding the Importance of Business Succession Planning

Running a business can be an all-consuming affair leaving little time for contemplation of what happens to the enterprise in the event of a family tragedy or a business partner retiring or dying.

But in fact, these type of events should be considered by all owners as part of business succession planning, which we’ll discuss in this article. This planning process is essential to not only protect the wealth you’ve built within the business, but also provide clear direction around your legacy – what does the business look like once you or your partners move on.

Creating a buy-sell agreement

Unfortunately most business owners end up reacting to sudden events which threaten the viability of their enterprise, rather than plan ahead for them. A dispute with a partner, external legal action by a client, illness, death, divorce, disability and bankruptcy are all in the nature of events which can threaten a person’s stake in a business and their ability to pass on wealth in the entity.

One way to deal with the possibility of such events is the creation of a ‘buy-sell agreement’. This agreement, which sets out what will happen to each party’s interests in the business should an event force them from the business, can be incorporated into an existing company constitution, partnership or stakeholder agreement, and pre-empts what needs to happen if any of the aforementioned events transpire.

Ideally the agreement provides certainty and transparency on the steps to be taken if an event which seriously impacts the running of the business occurs – how any change to the ownership structure will be dealt with, how any exiting directors or partners will be paid out, how contingencies such as legal action will be paid for, and more. Importantly it provides notice to all those involved in the business so they can take steps to protect their investment in the business, by taking out – for example – insurance to cover the unforeseen event. Spending time getting this agreement right is all part of diligent business succession planning.

Questions to be asked in creating a buy-sell agreement

Business owners should be able to answer a number of relevant questions in the process of creating a buy-sell agreement, including:

  • How is your interest in the business valued so that if you need to exit the enterprise, it can be sold to other interests at a fair price?
  • Who are the likely buyers of the interest and how do they plan to fund its acquisition?
  • What are the tax implications and consequences for the business if you sell to a third party or an interrelated party?

Key considerations in successfully implementing a buy-sell agreement

Identify the parties to the agreement: Is the agreement only between business partners or are the spouses or partners of the principals also parties? This is a pertinent question if any of the owners are going through a separation or divorce and business assets potentially become part of a financial settlement.

Which events are covered by the buy-sell agreement: To obviate the need for possible legal action later, it’s important to detail which events are covered by a buy-sell agreement. It’s advisable to be as comprehensive as possible in drafting this section to accommodate all potential situations. Typically, death, disability, divorce, default (such a bankruptcy), retirement, resignation, irreconcilable disagreement (between principals or partners) and decision-making deadlock are common events covered in such agreements.

Covering off these events generally provides more detail than existing exit clauses in stakeholder agreements or company constitutions, so those documents should be checked to prevent overlap or inconsistency.

How to value the business: Disputes often arise over the value of the business and each party’s interest in it once an event covered by the buy-sell agreement arises. The assistance of an accountant or a licensed valuer will often be required to value the business and determine its worth.

Working out termination profits and any other benefits: The buy-sell agreement should also cover what funds a departing owner/principal should take from existing business profits, as well as any other assets or benefits. Expert legal and financial advice is likely necessary at this stage.

Buy-sell agreements, like testamentary wills, should be reviewed and if necessary updated on a regular basis to ensure the document reflects the business’s current structure.

Discuss business succession planning with our expert team

The drafting of a buy-sell agreement as part of business succession planning is increasingly important in a litigious world. It is important to undertake this process before certain events arise in order to protect the viability of a business and provide certainty for all parties about the future of the enterprise.

Our experienced team at PD Law can help draft such an agreement with business owners and help you understand how it fits in with your existing company documents, such as stakeholder agreements. We will also help you understand the implications for tax and estate planning. If you have questions about the points raised in this article, please call our professional team as soon as possible.