ProAdviser - Contingency Planning

Retirement,Small Business

Will Your Business Have To Retire When You Do?

29 Jan , 2014  

Nikhil (Nik) Sreedhar
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Nikhil (Nik) Sreedhar

Founder at ProAdviser
Nikhil's dream job is to be an exotic car salesman. His favourite colour is orange and it shows as he is the 23 year old entrepreneur behind ProAdviser. You should follow him, he gets lonely.
Nikhil (Nik) Sreedhar
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Contingency Planning is all about protecting the assets of your business and the owners from liabilities which may be incurred as the result of unfortunate circumstances involving key persons to the business or principal owners.


It’s very easy to overlook some important financial considerations, ensuring plans to protect your business against adverse events that will affect liquidity and profitability. Most businesses owners have made no provision for what will happen to their Business when the inevitable happens. Either, it’s time to hang up the boots and retire, or worse, they become gravely ill or die.


The lack of planning isn’t usually done on purpose, but more often because business owners are unsure of where to turn for help or even how to plan for such an event. 


Key aspects worth consideration should include:


• Business Loan Protection

• Shareholder / Director and Beneficiary Loan Protection

• Key Person Revenue Protection

• Business Succession Protection

• Regular Reviews as the business grows


Making allowances for your interest in your business when you can no longer actively be involved forms part of estate planning for our legacy and family provision.


So What Could Possibly Go Wrong?
Failure to take care of Business Success Planning may result in undesirable outcomes:


• Your life partner and/or family may not receive the full value of your business interest after you’ve gone;

• Your business partners may be left to run the business with your spouse and/or children who likely have no skill, experience, expertise or wish to run the business

• Lending institutions may call in personal guarantees and supporting securities

• Business may have difficulty meeting commitments under Director loans and face serious liquidity problems

• The loss of a Key Person due to sickness or death, especially one who drives most of the revenue for the business, could cause a severe loss of profit

• An unforeseen illness or injury to an Owners or Key Person does not stop fixed overheads from needing to be paid


All events raise a series of interesting questions and have simple solutions. If these aren’t put in place, considered or acted on, the results for your business may even result in its’ complete closure or liquidation.


Likely you have envisioned something different and a lot more positive for both the business and your family.


Consider the following Case Study: Three mates become partners in a small business together. Alf, Bart and Charlie are the shareholders of ABC Pty Ltd which owns a business worth $600,000. The break-up of interests is:


• Alf owns 4 Ordinary Shares valued at $200,000

• Bart owns 5 Ordinary Shares valued at $250,000

• Charlie owns 3 Ordinary Shares valued at $150,000


The business is growing and is the primary source of income for all three men and their families. Things are going really well for them, and they have not considered the consequences to the business if one of them were to die, become disabled or seriously ill. They have no business succession plan or insurance protection strategies in place. But, otherwise, all is good.


Unfortunately, Bart, a key contributor to the business, is involved in an accident and dies. Alf, Bart and Charlie have no agreement in place which provides for what happens to the shares in ABC Pty Ltd and how the business will continue to trade after the death of one of them.


Bart’s shares in ABC Pty Ltd (estimated at $250,000) are now owned by his Legal Personal Representative (the Executor of his estate, in this case, his wife) for the beneficiaries named in his personal will. Bart’s Executor has a legal obligation to administer his estate by collecting, selling and distributing Bart’s assets to the beneficiaries, including Bart’s shares in ABC Pty Ltd.


Bart’s Executor has strict legal obligations to do this and has no need to consider the financial well-being of Alf, Charlie, ABC Pty Ltd or the continuation of the business. The Executor also has the right to receive full dividend distributions derived from ABC Pty Ltd even though they do not contribute to the operation of the business or the creation of profits for ABC Pty Ltd.


With Bart no longer contributing to generating business income, and the men distraught at losing a mate, the business starts losing money and ABC Pty Ltd cannot afford to hire someone to replace Bart. Alf and Charlie ideally want to continue to carry on the business without the meddling of Bart’s family (they never really liked his missus anyway) and without having to share the profits which they are working hard to obtain.


They are sharing the dwindling profits of ABC Pty Ltd with Bart’s family, and need to deal with Bart’s wife who wants to sell Bart’s interest (potentially to a competitor who will pay an above market price.) Even if Alf and Charlie convince Bart’s missus to sell them Bart’s shares in ABC Pty Ltd, Alf and Charlie would need to fund the purchase of Bart’s shares from their own sources (i.e. personal savings, or a loan which would place further strain on business cash flow.)


This could have all been prevented if a buy-sell agreement also known as a Business Will, was in place.


How: The buy-sell agreement is the cornerstone of any business succession plan. It is a contract that sets out the rights and responsibilities of the parties and addresses timing, terms, and funding (usually through life insurance) of the purchase and sale of the shares in the company which owns the business. A good buy-sell agreement should include:


• A mechanism to financially enable the remaining shareholders to purchase the shares of the exiting shareholder. A buy-sell agreement is typically funded with insurance policies

• A predetermined method of valuing the shares to be transferred

• Predetermined circumstances that trigger a transfer (e.g. death, total and permanent disability, trauma, divorce or retirement etc.) and

• Dispute resolution clauses


This agreement is an important tool in providing for a planned, orderly transfer of the shares in the company which owns the business, with minimum disruption. Some of the advantages of a buy-sell agreement are to provide for business continuity, and ensure that the ownership of the business remains with the individuals elected by the owners.


What do you need to do? If you have business partners, they need to agree with your business exit plan to ensure it is actioned when the time comes.


In order to develop a business succession plan, speak to your accountant, solicitor and risk adviser who will advise you on the development of an exit plan that best suits you, your business and your family. Often a risk adviser who specialises in this area will have ties to the other professionals who can assist with business valuations and the appropriate agreements.  


To find the best suited professional, just submit an Advice Request by clicking here.

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