Legacy planning is an essential part of ensuring your business continues to thrive for generations to come. And at the heart of it lies a well-crafted buy-sell agreement. In this blog, we'll simplify complex topics and guide you through six critical questions to consider when drafting your buy-sell agreement, so you can secure your business legacy with confidence.
Exiting owners often require a significant amount of capital for their buyout, which can put immense pressure on the business's financial health. It's crucial to address this challenge in your buy-sell agreement. So, let's explore various funding options that can alleviate financial strain and ensure a smooth transition for your business.
Lump-sum payments: One approach is to determine a fair market value for the departing owner's share and arrange for a one-time lump-sum payment. This option provides immediate liquidity and allows the exiting owner to exit the business swiftly.
Installment payments: Alternatively, you can structure the buyout as a series of installment payments over a defined period. This spreads the financial burden over time, providing more flexibility and reducing the immediate financial impact on the business.
Gradual stock transfers: Another option is to gradually transfer ownership shares to the remaining owners or new investors. This allows for a phased transition, minimizing the need for large upfront payments while ensuring a smooth transfer of ownership.
Insurance-funded buyouts: Consider leveraging insurance policies, such as life or disability insurance, to finance owner exits. By securing appropriate insurance coverage, the proceeds can be used to fund the buyout, reducing the financial strain on the business or other owners.
For the sake of simplicity, if two shareholders, X and Y, each own 50% of a business with a total value of R10 million, the buy & sell policies would need to be structured as follows:
X would take out a policy on Y’s life to the value of R5 million, being the value of Y’s 50% share. Y is the life insured while X is the premium payer and the policy owner. Similarly, Y would take out a policy on X’s life for the same value and would be the policy owner and payer. In the event of X’s death, the proceeds of the policy would be paid to Y which he, in turn, would use to purchase X’s shares. While this is a fairly simplistic example, bear in mind that business shareholding and structuring can be particularly complex and, if the buy & sell policies are not correctly set up in terms of the life assured, payer and policy owner, it may not be deemed a buy & sell policy for tax purposes if and when an event is triggered.
In terms of the Estate Duty Act, the proceeds of a life policy are deemed to be an asset in the estate of the life assured for the purposes of calculating Estate Duty. It is possible for policies taken out for the purposes of Key-Person or Buy-and-Sell plans to meet the requirements for an exemption from Estate Duty. Section 3(3)(a)(iA) of the Estate Duty Act allows an exemption if the following requirements are met:
If any requirements have not been met, the policy value must be increased to make provision for the liability of Estate Duty on the value of the policy.
The Covid-19 pandemic brought unprecedented challenges to businesses worldwide, causing many owners to reevaluate their buy-sell agreements. During this time, some astute business owners capitalised on the temporary decline in business value by transferring their assets into trusts at a reduced valuation. Others implemented temporary adjustments to their valuation calculations and owner stipulations, safeguarding their businesses while navigating through the storm.
To illustrate, let's consider an employee interested in purchasing shares in their company during the pandemic. Due to the existing valuation formula, the transaction would have been disadvantageous for the owner, as it would have been significantly undervalued. Recognizing this, a careful review of the business owner's buy-sell provision in the operating agreement led to the inclusion of a new section, allowing for the normalization of earnings during periods of temporary stress. This proactive approach has become increasingly prevalent in buy-sell agreements, incorporating "failsafe" clauses that protect businesses during unforeseen, typically short-term events.
There are three main approaches to determining a company's worth: the asset approach, the market approach, and the income approach.
Each approach has its strengths and limitations, and depending on the circumstances, one approach may be more suitable than others. Understanding these valuation approaches can help business owners, buyers, and sellers make informed decisions about the value of a business.
When the time comes for you to step back, it's crucial to have a solid plan for your business's future. I can help you explore different scenarios, such as passing the torch to family members, empowering key employees, or selling the business. By considering these options, you'll shape a legacy plan aligned with your vision.
Securing your business legacy requires careful planning and foresight. By addressing these six critical questions when drafting your buy-sell agreement, you'll create a roadmap for a successful transition and ensure the longevity of your business. Don't leave your legacy to chance—take control of your business's destiny and set the stage for a thriving future.
Remember, your business's impact can last far beyond your tenure. Embrace the power of a well-structured buy-sell agreement and leave a lasting legacy for generations to come.
Ready to secure your business legacy? Set up a consultation with me today to craft a customised buy-sell agreement tailored to your unique needs.