The need for appropriate legal agreements between partners may seem painfully self-evident, but some sources indicate that as many as 95% of businesses may not have the right kind of agreements in place. Which means that up to 95% of businesses are going to go through a lot of pain.

In practical terms, an exit by one of the partners is inevitable – sooner or later someone will leave. These reasons could include retirement, death, illness, a disagreement or even a divorce as part of a financial settlement.

There’s a lot of their wealth tied up in a business. But often there’s not a lot of planning for the breakup or how a buy-out could be funded. This can lead to immense problems not only for the departing proprietor, but also for the business and the remaining business owner(s).

There are a number of issues to consider in these scenarios including:

• Who the buyer will be (more often than not, the existing partner)
• How much will they pay – what is the business worth?
• How will they pay for it and over what timeframe? Is it possible to get insurance to help pay for it?

Some of the specific issues we see where an appropriate business succession plan does not exist include the following:

• Your business partner dies. How will you feel if your business partner’s spouse wants to come in and run the business in their place?
• Your business partner is ill and can no longer work and wants to get out of the business. His/her spouse doesn’t want anything to do with the business and they need to sell their share. Would you buy their share and how would you fund it?
• Your business partner has a chronic illness and you don’t know how long it will be before he/she can come back to work, if at all. How long would you be prepared to fund them their share of business profits without them actually contributing in any way?
• What if you die and your spouse is left to deal with your share in the business? How would they go negotiating with your business partner to sell that equity?
• What if you are ill and can no longer work and you would like to sell your share to your business partner but he/she refuses to buy your share? What will you do? Will your share retain its value given your predicament and considering that a buyer may be difficult to find?

An effective business succession plan involves a well structured legal agreement as well as an effective funding arrangement for the exit of a business partner. It is vitally important that both aspects are in place, as having one without the other will generally lead to disaster for all parties concerned. Funding arrangements for business succession typically involve the following:

• Cash
• Debt
• Life Insurance

Of the funding options listed above, life insurance is generally the most cost effective way of funding an involuntary exit of a business partner. Examples of involuntary exit trigger events include death, permanent disability and critical illness. When considering life insurance as an appropriate funding solution it is important that the following areas are addressed:

• The type of insurance cover
• Who owns the insurance
• How much cover should you have
• Who pays the insurance premiums

If you have not received appropriate advice on the above it could have serious financial and tax implications for you and your business partner(s) and could even invalidate your legal agreement.

If you would like to know more about the importance of a business succession plan and how Elston can assist please speak with your Elston adviser.