Where a business is run by multiple owners, it is important to secure the ongoing viability of the business in the event that one of the owners passes away or suffers from a critical injury, disability or illness. A Business Succession Agreement is a useful tool to ensure the seamless transfer of ownership over the company in one of these unfortunate events.
The importance of a Business Succession Agreement is best explained through a hypothetical scenario. Let’s say that two owners named Cathie and Barney carried on a business supplying building materials to government builders. When Barney died, Cathie offered to purchase Barney’s shares in the company from his estate. However, Barney’s Will left everything equally between his two teenage sons, Bill and Bob. Unfortunately, the boys fancied themselves as business owners. Rather than selling the shares, the boys insisted on taking an active role in the business. After a year of indecision, arguing and stagnant growth, the business failed.
The failure of the business could have been avoided if Barney and Cathie had executed a Business Succession Agreement which transferred Barney’s interest in the company to Cathie as the continuing owner.
Essentially, a Business Succession Agreement is a legally binding document which stipulates what happens to each owner’s respective interest in the company should they pass away or lose the ability to continue running the business. Typically, this involves allowing the continuing owners to buy the outgoing owner’s shares in the company. This gives the remaining owners certainty that their rights to continue on in the business while also ensuring fair value for the family of the outgoing owner whose interest has come to an end.
This Agreement also ensures that third parties do not have an unacceptable level of control or influence over the business, the estate cannot demand an unreasonable amount for the interest in the business, loans are not called in without proper funding, and the continuing business owners can protect the asset that they have worked hard to build up.
The Agreement functions through a grant of an option in favour of the continuing owners to purchase the outgoing owner’s interest. At the same time, there is a grant of an option for the outgoing owner or their executor to require the continuing owners to purchase the interest in the business on set terms. The Agreement will also set out the mechanisms by which these options can be exercised and the time periods within which a valuation of the interest must occur and payment of that interest.
To fund these buy and sell obligations, the Agreement may impose obligations on the parties to maintain policies of insurance to provide all or part of the funds to purchase the outgoing owner’s interest in the business.
Ultimately, a Business Succession Agreement is only part of an overall strategy that must be formulated. It is imperative that the other documents that form part of the legal framework under which a business operates are reviewed carefully. Therefore, Trust Deeds, Company Constitutions, Loan Agreements and other arrangements must be reviewed and, where appropriate, updated. It is our pleasure to assist our clients and their advisors in achieving these goals. Should you be interested in arranging a Business Succession Agreement, please contact Tony direct on (07) 3317 4312.