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Insufficient succession planning

Have you given thought to what will happen upon your death? Often, business owners simply leave everything in their will to their spouse, unaware that the business interest will be dealt with in the same manner. Suddenly your business partner has your wife as a new partner in “his” business. You can imagine some of the less favourable scenarios playing out in such a situation. The opposite can also be true: suddenly you could have your previous business partner’s spouse to contend with.

Traditionally, a buy and sell agreement can smooth out the process of transferring one partner’s share of the business to the remaining partners.

The agreement states the terms and conditions for such a transfer and can provide the following for all the business partners, their surviving spouses and family members:

  • Certainty on what will happen to their share in the business should they pass away
  • Mutual agreement about what valuation method will be used to determine the market value of the business
  • The timeframe within which transfer must take place
  • The funding mechanism that will be used to buy the deceased partner’s share
  • Having a signed and up-to-date buy and sell agreement is therefore crucial. Of course, having the right funding mechanism in place is equally important. The right cover that makes provision for death and disability can ensure your family receives the value of your life’s hard work while your business partners can continue running the business effectively.

    Should you be the only person in your business, there is the option of doing a one-sided buy and sell agreement if you have identified a key employee that can take over your business upon your death or disability.

    Part of succession planning for your business is also to consider what will happen with your business interest when you retire. When exiting the business, you would want to ensure that you extract the value that you’ve built up during your lifetime. Here you can agree with your business partners or a potential successor on how you will receive your share of the business value – either as a lump sum or an ongoing annuity.

Loss of a key person

In your business there will be at least one key person – someone that is instrumental in the success of your business due to his/her skill, expertise and experience. Losing such a key employee can have a big impact on any running business operation, especially if it happens at a critical time. This can change the entire risk profile of your entity. Tendering for new contracts or applying for further finance may become a challenge without the leverage of the skill needed to secure a potential deal.

Replacing key employees can be a long and expensive exercise, especially if it’s a rare skill or key networking individual that is lost. It is, however, possible to prepare for such an event by having key person insurance, which will provide sufficient funds to find a suitable person or to carry the business while sourcing a replacement.

Contingent liability

Somewhere along the line, most businesses need financing of some kind. Signing surety for these debts can be a risk to the individual as well as the credit rating of the business. A business can insure against the debt, saving the individual’s family from undue financial strain and ensuring the business’s cash flow isn’t negatively impacted.

Business overheads

Losing a business owner can negatively affect the cash flow of any business. Just because the owner becomes disabled, as an example, doesn’t mean the usual monthly expenses fall away. Salaries still need to be paid, water and electricity bills are still received and rent is still due. Sourcing income protection for your business can ensure that regular commitments are honoured without disruption when a business owner falls away.

Loan accounts

The significance of a loan becomes evident upon the death of a business owner, as it suddenly needs to be settled.

Fortunately, provision can be made for the repayment of a loan on the death or disability of the business owner.

Business expansion

Technically this is not seen as a risk. If your business is expanding, surely that’s a good thing. It means your business is doing well. However, you need to consider where funding for expansion will come from. You may need to finance additional equipment or take on more key employees at great expense. There are various ways in which to address your expanding business’s needs with the help of a specialist.

Holding business interests in a trust

A trust is a separate entity and not the property of an individual. Transacting with a trust means transacting with a group of trustees responsible for the assets on behalf of the beneficiaries of the trust. This means that all parties need to understand and agree to the way business interests will be dealt with, during the lifetime of the business owner as well as when the owner passes away.

How does this relate to your estate planning?

When looking at your estate plan there are a few essential questions you should be asking about your different estate planning instruments. Taking out insurance against the business risks discussed above, can have estate duty implications. Involving another entity, like a trust, can also affect how the business interests are dealt with.

It is important to understand what assets are dealt with in your will and how to optimally structure your affairs to ensure your family receives the value of your business.

We recommend approaching a specialist knowledgeable in the field of business insurance as well as the estate planning intricacies involved.

Sanlam Life Insurance is a licensed financial service provider.
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