THE BUSINESS CONTINUATION PLAN FOR EQUITY
Whenever people come together in a business venture it is because they have complimentary skills, knowledge or experience, or because of financial considerations.
Their primary objectives are to make a profit and build an asset they can share.
If you are unlucky enough to lose a business colleague - through death, disablement or simply because he or she wishes to start a new venture, this could have a disastrous financial result for your business, for you and your family.
Have you thought what would happen to you personally if you were to lose a business colleague?
(a) Your colleague's interest in the business
Usually, you will have to find the money to pay out your colleague's interest in the business. It will also require a complete re-organisation of the business.
Will you be able to find someone else to buy into the business? Will you be able to borrow the money? What is the business worth anyway?
How will your business survive this financial strain?
(b) Future profitability
With one key person no longer helping to produce profits for the business, its long term future profitability is thrown into question. Will the bank call up any loan facility? Will your clients buy from competitors? Will your employees get restless and leave? Will your suppliers continue with credit arrangements?
Unless you manage to restructure your business effectively and quickly, you may find that you have to sell out at whatever price you can get for the business and suffer the financial consequences.
But there is a better way - a BUSINESS CONTINUATION PLAN can provide the cash funds to enable you to:
- Buy out your business colleague's interest at a predetermined fair price.
- Pay out all the debts on the business.
- Maintain profitability of the business for a period of time until you can find a new business colleague or until you otherwise restructure your operation.
There are two main components to a BUSINESS CONTINUATION PLAN.
1 LEGAL DOCUMENTATION
All the documentation you need to establish the plan can be arranged. This documentation may include:
- A Buy-Sell Agreement - this enables you to buy out your business colleague's interest if they die or become permanently and totally disabled.
- The Agreement will also enable you to fix the price at which the business interest will change hands.
- Board Minutes - evidencing your desire to set up the Plan.
- Legal and Taxation Notes - which explain the technical laws which govern the operation of the Plan and the rights and obligations of all parties.
2 FUNDING THE PLAN
Because a Buy-Sell Agreement is a legally binding contract, it results in a legal obligation for monies to be paid should an event occur which is the subject of the Agreement. Therefore, you need to arrange for the payment of the amount nominated in the Agreement. Additional sums may also be required to pay out any debts owed by the business or to fund a replacement person in a key role in the business. The three main ways of funding this are:
- from your own personal savings
- by borrowing the funds
- from the proceeds of a life insurance policy, total & permanent disability policy (TPD) and/or trauma policy - where your colleague's departure from the business is a result of death, disability or a serious health event and their departure is an Involuntary Departure
Whilst any one of these funding methods may apply in any given situation, the usual way of making provision for payment of the monies where there is an Involuntary Departure is by the use of insurance.
LOSS OF KEY EMPLOYEE
A similar financial loss can be incurred by a business if that business loses a key employee rather than the principal. Again life insurance can be used to protect a business against this situation.
HOW A BUY - SELL AGREEMENT WORKS
COMPLEMENTARY BUSINESS CONTINUATION AGREEMENTS
Buy-Sell Agreements are limited to funding a departure from the business which arises due to an event that can be covered by insurance - not departures that occur because your business colleague wishes to retire or leave the business for any other reason - a Voluntary Departure.
Voluntary Departures are often dealt with in a separate agreement. These agreements often also specify how the business colleagues wish to operate their business and regulate their relationship as business operators and owners. One such agreement is a Shareholders Agreement. I will in coming weeks post a blog dealing with these issues.