Succession Plan Buy-Sell Agreements

Succession Plan Buy-Sell Agreements

You work with one or more business partners. Most likely all business owners
involved in the day-to-day management of the business. But what happens if you or they die or
retire from running the business? Here we outline some of the problems you may encounter unless you have a proper business succession document (often called a Buy/Sell Agreement). We also outline some of the options and issues in entering into a suitable buy/sell agreement. These issues are the same whether your business is run through a company, unit trust or partnership.

Common problems
These are some of the common issues that business owners can face when any of the above events occur: Disputes between the continuing owners and the new owner of the business (the new owner may acquire their interest under the will of the deceased former owner ). This often happens because the new owner doesn’t understand the business or doesn’t have the respect of other business owners; in a private business, selling part of the business to an outside party is often not possible (ie there is limited external liquidity). So there can really only be sales between business owners. However, without an agreement: the new owner (under a will) cannot force the other business owners to buy his or her part of the business; and the remaining business owners cannot force the sale of the deceased business owner’s portion of the business; even if all owners want a sale to take place, there is insufficient funding to allow this; owners still working in the business become unhappy about having to pay ongoing returns to the new passive owner (ie the estate of the deceased owner); and concerns about business continuity and viability, including from employees, customers, bankers, suppliers and creditors who may leave or cease support (especially when owners are in dispute).

Purchase/Sale Agreements
Entering into a buy/sell agreement can avoid some of the above and provide security
business owners. In simple terms, a buy/sell agreement provides a framework where business owners can sell their interest in the business or buy out a co-owner’s interest. For tax purposes (see below), buy/sell agreements typically use options to buy or sell upon a specified trigger event (eg death of owner). Usually: owners not subject to the triggering event have the right, but not the obligation, to buy the leaving owner’s interest in the business (call option); the owner subject to the triggering event has the right, but not the obligation, to have the other owners buy his or her interest in the business (a put option).

Alternatively, a repurchase/repurchase agreement may be considered. In such arrangements, the trading entity (eg a company) buys back the exiting capital, not the other owners
owner shares (note that there are Corporations Act requirements that apply to share buybacks).
Another alternative is to have a sale of the entire business upon the occurrence of a triggering event. We don’t
Check out these two options in this article. Now we look at some of the problems you need to do
consider and decide to make sure you meet your needs.

You need to understand the triggering events or conditions that lead to the sale of a business share. These are often tailored and limited by available financing for each purchase (see below). There are two broad categories of triggering events, namely: involuntary or insurable triggering events (death, critical illness and total permanent disability); and voluntary or uninsured triggering events (retirement, resignation or legal termination of employment).

Call options are typically granted upon the occurrence of both involuntary and voluntary trigger events. Put options are typically granted upon the occurrence of unintended trigger events. As insurance is not available for inadvertent triggering events, you may need to consider price reductions or payment over time (provider financing arrangements).

The price at which an existing owner’s interest in the business will be sold must be fixed under
The Purchase/Sale Agreement and is reviewed at agreed intervals. Alternatively, the parties should agree on an appropriate valuation methodology and/or peer review process. All scenarios that could justify a reduction in the price due should be carefully considered. For example, a reduction may be appropriate in the case of Put Options for voluntary trigger events as mentioned above (say, if an owner is evicted for breach of a Shareholders Agreement or terminated for fraud). Abatement may also be appropriate in circumstances where a departing owner does not maintain an insurance policy as required under the Purchase/Sale Agreement or otherwise invalidates an insurance policy.

A buy/sell agreement is often financed in whole or in part by insurance policies. For tax purposes, “principal ownership” is usually used (meaning that each business owner owns their own
insurance policy). There are other options for owning an insurance policy, but these can have
adverse tax consequences (including capital gains tax consequences on the payment of
insurance policy proceeds). There may also be tax differences in the treatment of insurance
premiums. So tax advice is crucial in these matters.

Alternatively, owners may decide to use their own equity, borrowing money to finance
sale and/or entering into a supplier financing agreement. However, it is difficult to predict whether, at the time a sale is required, the owners will have the funds available to make the purchase. The parties should consider the payment schedule (upfront lump sum or payment over time in installments). If payment is to be made over time by installments (supplier financing), collateral (e.g. mortgage) and interest must also be considered.

Capital gains tax
Care should be taken when drafting purchase/sale agreements. Options should be used to avoid undesirable capital gains tax (CGT) consequences. The conclusion of virtually any agreement can be a CGT event. However, a Buy/Sell Agreement using options without consideration will not trigger a CGT liability at the time of signing. Rather, the CGT event and the resulting CGT liability will arise on the exercise of the options (ie when an unconditional agreement to buy and sell a share of the business comes into force).

Similarly, where a business succession agreement (including a Buy/Sell Agreement) does not use options but makes the sale of a business interest conditional on the occurrence of an event, the CGT event will not occur on signing but on the fulfillment of that condition. If the buy/sell agreement includes supplier finance, careful consideration should be given to CGT. Otherwise, the seller will incur CGT and liability for one year, but may only receive the sale price for a few years.

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