You have equity in a business you own with other people.
You'd be unable to pay out the other owner's share in the business.
You'd like peace of mind in the event something happened to your business partner.
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The generational transfer of wealth is seldom thought about and even less understood. Your life’s work is not something to take lightly – start planning ahead today.
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Being your own boss is extremely appealing, but without the right support, finance and advice, it can be hard to get your business off the launchpad.
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Succession Planning (1)
Putting an agreement in place
A Buy-Sell agreement, also known as share purchase or partnership protection, is an important business exit strategy. For example, if you are insured and were to die or become disabled, both your business partners and your family would be protected.
The four most common reasons for exiting a business are the four Ds – death, disability, divorce or departure. While divorce and departure are voluntary, death and disability aren’t.
Buying insurance cover to provide the funds to implement a written agreement on how one or more owners can exit the business will protect you against the four Ds.
The risks of not having an agreement
If a business partner dies and no succession plan is in place, the share of the business is likely to be:
- Distributed in accordance with their Will (eg. to their surviving spouse)
- Otherwise controlled by their beneficiaries (eg. if the interest is owned via a family trust).
As new part owner of the business, your partner’s spouse or beneficiaries enjoy the same management and financial rights as the deceased did. However, they may not have the skills or inclination to assist in running the business. Will you have the money to buy out your new partner’s equity in the business?
Similar problems can occur if a co-owner of the business becomes disabled and unable to work. To protect your business and ensure an orderly transfer of ownership, a buy-sell agreement should be considered.
What is a buy-sell agreement?
A Buy-Sell agreement is a legal contract between business owners usually comprised of two components:
1. A transfer agreement that outlines what will happen to each owner’s business interest if certain events occur, and how the interests will be valued.
2. A funding agreement that outlines how the money will be raised to finance the ownership transfer and who will receive it.
There are numerous ways a Buy-Sell agreement can be funded:
- Using your own capital or borrowed money
- Through insurance
When it comes to death, disability and critical illness, insurance is usually considered the most cost-effective and efficient way to raise sufficient capital.
Benefits of a buy-sell agreement funded through insurance
A Buy-Sell agreement funded through insurance makes sure sufficient funds are available to compensate your business partner’s family for the transfer of their share in the business to you, without further cost.
Funding the Buy-Sell agreement through life or total and permanent disability insurance means the financial impact on you and your business is minimised, and the business can continue with minimal disruption.
If you did not have this insurance in place, you would have to dig into your own pockets and fund the buyout of your partner’s share of the business or continue in business with your business partner’s family or estate. This is often not a desirable or viable option.
Likewise, this strategy would enable your partner to buy out your share of the business if you were to become disabled or die, providing adequate compensation for your family or estate.