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By André Basson and Leslie Greyling*
Preparing for the unexpected is as important for business owners or partners as the development of the business itself. As with many aspects of life, setting up a business presents risks that can deliver catastrophic consequences if no plan is in place to address the unforeseen. One aspect that is often overlooked is the continuation of the business. What will happen if one of the partners passes away or is other otherwise injured in such a way that they can no longer stay an active partner in the business? It is possible to structure an agreement whereby in the event of the unforeseen occurring, the remaining partners are able to purchase the shares of the partner and thus allow the business to continue. Such an agreement is referred to as a buy-and-sell and, if structured correctly, is one of the most powerful tools to ensure that the original vision of the business can be met even after a partner is no longer around.
At its core a buy-and-sell agreement is merely a legal document that states who will purchase a partner’s shares if the partner passes away or becomes permanently disabled. Often a risk policy is taken out with an insurer to create the capital needed to purchase the shares.
If we take a basic example, Bob and Dave start a company with Bob owning 60% of the shares and Dave the remaining 40%. There is no buy-and-sell agreement in place as Bob and Dave are lifelong friends and have not thought about anything bad happening. Unfortunately, Bob passes away in a motor vehicle accident. His will states that all his assets must go to his spouse. As there was no buy & sell agreement in place, Bob’s 60% shareholding in the business will go into his estate and eventually be transferred to his wife. Bob’s wife is now the majority shareholder and can make decisions that could jeopardise the business. She might also not prefer to be in this position, but Dave cannot buy her out due to the lack of liquidity. Whilst Dave cannot buy her out, she will remain a “sleeping partner” but with voting rights to and rights to dividends / income. She would much rather prefer to Dave to buy her out and use the capital to spend on her own priorities.
In order to put together an effective agreement, and prevent a scenario such as the one above, there are some key points that a buy-and-sell agreement must address. These are:
- When, and under what circumstances, a business may dispose of an owner’s interest.
- Whether the other owners or the business have the opportunity to buy the interest from that owner prior to its disposition to an outside party.
- How much to charge for that interest.
- Whom the remaining owners are willing to accept as a substitute owner.
A buy & sell agreement can facilitate a transfer of wealth to the family of the existing partner, and provide continuation of ownership to the remaining partner in the following way:
- The buy-and-sell agreement stipulates the agreed method to calculate the value of the interest or shareholding each partner has in the business.
- Upon death of a shareholder, the remaining shareholder buys out the relevant share and pays it over to the estate of the deceased. The buy & sell agreement supersedes the will.
- The funds received by the estate will be distributed according to the stipulations in the will (make sure the will is updated), to the beneficiaries of the estate.
- The remaining shareholder acquires the remaining shares and retains ownership and control of the business. He can then decide to appoint a manager and take his time to look for a new partner (if he wishes to do so).
- This acquisition can be funded by a life cover policy (which both partners takes out on the lives of each other), debt or cash. The latter two are not often found in practice, as successful businesses deploy extra cash into the business and do not keep it for an unforeseen event of this magnitude, whilst adding such a big amount of debt increases the risk of bankruptcy.
You can avoid a lot of risk by having a binding buy-sell agreement in place, creating continuation and wealth for the relevant parties. Without a clear succession plan, disputes can arise among partners—or their surviving spouses or heirs —that lead to loss of valuable time, increased expenses, and costly litigation.
- André Basson holds a B.Com degree from the University of Stellenbosch, finishing top of his Financial Planning class. His also holds a B.Com Honours degree and a Postgraduate Diploma in Financial Planning. He completed the Advanced Postgraduate Diploma in Financial Planning from the University of the Free State. He joined Brenthurst Wealth in 2018.
- Lelsie Greyling is a Registered Financial Planner and has 21 years experience in the Financial Services Industry with 14 years as an Independent Financial Advisor. She is a member of the Financial Planning Institute of Southern Africa (FPI) and a risk specialist. She joined Brenthurst Wealth in 2018 as a Risk and Investment Advisor.
Read more: Risk planning.