Who or what is at risk?
When Advisers are helping clients with Business Succession Planning, it's important to understand the dual nature of the risk. Not only is the business entity itself at risk, but so too are the individual partners.
The exit scenarios...
Business Succession Planning for some Advisers involves considering what will happen if one of the partners dies, suffers a Total and Permanent Disablement (TPD) or a critical illness. We also believe it's important to manage risk around an exit that is not insurance funded.
More on both exits is available here. but for now we will look at those exits that can be covered by insurance and supported with Buy Sell Agreements.
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The business is at risk...
If a partner was forced to leave a business due to ill health or death, the business itself is vulnerable. Was that person a key person? Can they easily be replaced? How will the business pay for that?
Has the client read the fine print on their loan contracts? Many of them have an automatic default in these circumstances so can the remaining partner afford to pay the loan out? Often not, especially when they may be struggling after one partner has left. Of course personal guarantees may have been signed... but more on that later.
Fortunately business insurance is available from life companies to help in these scenarios.
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The individuals are also at risk...
For many small to medium business owners, their business comprises a large part of their total assets. They have often not only invested a lot of time (and blood, sweat & tears) but also money to both get and keep the business going. And of course if they have borrowed, they will probably have provided personal guarantees which usually means their house is also vulnerable. All of that means they can have a lot to lose.
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The value of their equity in the business is at risk. Could the remaining partner afford to pay them out? How long would that take?
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Capital Gains Tax may also be payable. When a partner exits the business and their equity transfers to the remaining partner/s the departing partner (or their estate) may be liable for CGT. |
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Business owners sometimes borrow from the business over time and if so, this will need to be repaid when they exit. |
Again, insurance cover is available for each of these elements.
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The cross-over risk
- personal guarantees
We mentioned the business risk above, with loans owed to banks that have personal guarantees attached. If a business loan is called up because one partner dies, the individual's assets may therefore also be at risk, not just those of the business.
If the business cannot repay the loans, the bank may have the right to call on the assets it has taken as security. For most business owners this is their house. So when a partner exits the business they will want to ensure any personal guarantees they signed have been extinguished. Suddenly both the remaining and departing partners have a vested interest in getting bank debts paid out.
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Helping your clients with business succession planning
If you have put insurance in place for clients, it is essential that they have a Buy Sell Agreement in place. Who will the surviving partner look to when there is no agreement in place to force the equity transfer? Don't leave yourself exposed. We provide fixed fee Buy Sell Agreements for clients around Australia. All we need is a name and phone number
emailed to referrals@irongrouplawyers.com.
If you want to extend your skills in this area, you may like to attend a Business Succession Planning workshop. For more information refer here.
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