No matter what type of business you’re in, it’s important to protect yourself against the unexpected – what we refer to as the “Seven Dogs”: Death, Disability, Divorce, Default, Departure, Disagreement and Deadlock
When one of these events occurs, often one business owner will want to take ownership and control of the business, and the other owner (or their family) will want funds to maintain their lifestyle.
A lot of questions then arise: primarily, at what price can one owner buy-out the other owner? How will the buy-out be funded?
If you have not clearly answered these questions before an event occurs, it can be very difficult to get a fair outcome after the event. After an event has occurred, one owner is likely to have the upper hand.
This is why canny business owners enter into a ‘Buy-Sell Agreement’ before an event has occurred – at a time when all the parties are on an equal footing. The Buy-Sell Agreement then facilitates an orderly transfer of the departing owner’s interest in the business – and in a way that can be funded by the remaining owners.
There are four key issues that need to be addressed when putting in place a Buy-Sell Agreement:
- What events will trigger the Buy-Sell Agreement, e.g. Death, Disability, etc;
- What will happen when the event occurs, e.g. either a transfer of a business interest, or the granting of an ‘option’ over the business interest;
- What value will be placed on the business interest – which may be a fixed value, or a value to be determined according to an agreed method; and
- How the buy-out will be funded – which may include the personal funds of the continuing owners, agreed ‘vendor finance’ terms from the departing owner, or more commonly, Life, TPD and Trauma insurance.
It is important that the answers to these questions are practical and match the realities of the owners’ circumstances.
Some key things to be aware of:
- You need to carefully consider how your business interest is to be valued. A fixed agreed value provides certainty, but the value can easily go out of date;
- A Buy-Sell Agreement is a very important document – but it is also very powerful. You are effectively agreeing to the sale of your business interest – albeit only if certain events happen. Accordingly, we strongly recommend that the agreement is prepared by a competent lawyer (us!), and that you get sound advice from a qualified financial planner on the insurance aspects; and
- There are a number of ways to structure the ownership of any insurance policies used to fund a buy-out. Each ownership method can have different tax outcomes. Accordingly, your lawyer will need to take this into account when structuring the agreement, and your financial planner will need to ensure the policy details properly reflect this.
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WARNING & REPUBLISHING
This publication contains general information only, and is not to be construed as legal advice. Laws differs in each jurisdiction in Australia, and may be interpreted or applied differently depending on your location. This publication is not to be used as a substitute for legal advice tailored to your individual situation. Use of this publication does not create or constitute a solicitor-client relationship between Andreyev Lawyers and any user of this publication.
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