Business Succession Agreements

The primary role of a Business Succession Agreement is to regulate the sale and purchase of a Business Person’s Equity in a Business upon Retirement or the occurrence of an Insured Event.

When an Insured Event occurs, Insurance Proceeds normally fund the agreed Purchase Price.

When the Business Succession Agreement deals primarily with the sale and purchase of the Equity upon the occurrence of an Insured Event (a Simple Succession Plan), it tends to be called a Buy/Sell Agreement.

IGS Business Succession Agreements also deal with Retirement.

They offer greater benefits than a normal Buy/Sell Agreement.

Shareholders Agreements and Partnership Agreements

Traditionally, there have been very basic provisions dealing with this issue in standard Shareholders Agreements and Partnership Agreements.

However, it is now common practice to prepare a dedicated Business Succession Agreement, because of a number of Capital Gains Tax and related commercial issues.

Options to Purchase ("Call Options")

The standard provisions in a Shareholders Agreement or Partnership Agreement usually consist of:

An Option to Purchase the Outgoing Proprietor’s Equity exercisable by the Purchasers only (a “Call Option”); and
A requirement that the Purchase Price be determined by a valuation process.

This gives certainty to the Purchasers, but not to the Vendor.

The Vendor (usually the Deceased Life Insured's Estate) will not know whether a sale will take place or what the Purchase Price will be, unless and until the Purchasers exercise their Call Option.

Usually, the Purchasers will not exercise their Option unless:

they are prepared to pay the required Purchase Price; and
they can fund the Purchase Price (either personally or by way of bank loan).

The second issue effectively makes the exercise of the Option conditional upon the Purchasers having a funding mechanism in place.

What if the Purchasers Don't Exercise the Call Option?

It is difficult for the Purchasers to exercise their Option, until they have determined the Purchase Price and assessed the feasibility of borrowing and paying this amount.

If they don't want to pay the agreed Price or can't afford to borrow or fund it, they would let their Option to Purchase (or Call Option) lapse or fall over.

The parties would then have to haggle over an alternative arrangement.

A Call Option gives the Purchasers certainty (if they want it), in the sense that it allows the Purchasers to fix or "cap" the Price they must pay to the Vendors.

However, it doesn't give the Vendors any certainty, until the Purchasers decide to exercise their Option.

In a sense, a Call Option creates a "Ceiling Price" for the Purchasers (i.e., a maximum Price thay can be asked to pay), but it doesn't create a "Floor Price" for the Vendors (i.e., a minimum Price they will receive).

Put Options

In order to give the Vendors certainty, the parties need a "Put Option".

A Put Option allows the Vendors to require the Purchasers to purchase the Equity for a Pre-agreed Price and on pre-agreed payment terms.

In effect, a "Put Option" is the reverse of a "Call Option".

IGS is reluctant to document a Put Option, unless there is a pre-agreed Funding Mechanism in place.

If a Purchaser commits to buy the Equity regardless of whether there is a Funding Mechanism in place, then effectively they are taking on a contractual obligation to pay the Purchase Price, regardless of whether they can ultimately obtain or borrow sufficient funds.

If they cannot obtain or borrow the funds, then they could be sued for breach of contract.

"Put and Call Options"

Where there is funding for the Purchase Price (e.g., because there is an Insurance Policy), it is usual for a Business Succession Agreement to contain two Options:

one exercisable by the Purchasers (the Call Option); and
one exercisable by the Vendor (a “Put Option”).

Because there is a funding mechanism for the Purchase Price, it is also possible for the parties to pre-agree the Purchase Price from time to time while the Proprietors are alive.

This avoids disputes with respect to the valuation after one of the Proprietors has died.

When combined, Advisers tend to refer to these arrangements as Put and Call Options or Put and Call Option Agreements.

Put and Call Options provide certainty to both the Vendor and the Purchasers, because it is likely that one or other Option will be exercised.

Retirement

Click here to read about the use of Put and Call Options in the case of Retirement.

Inadequate Insurance Proceeds

Click here to read about the use of Put and Call Options where it is not possible to obtain all of the Buy/Sell Insurance that is required to fund the Purchase Price.

"Conditions Precedent"

The same effect as Put and Call Options can now be achieved by properly drafted "Conditions Precedent".

CGT Issues

Both alternatives require careful drafting to avoid CGT liabilities.

Click here to read about the potential CGT liabilities.

This drafting is often not in standard Shareholders Agreements and Partnership Agreements.

Capital Gains Tax Issues

The introduction of Capital Gains Tax resulted in potential tax liabilities for all forms of Business Insurance (including Buy/Sell Insurance) under the Income Tax Assessment Act 1997 and earlier legislation.

As a result, it is now common practice to prepare a dedicated Business Succession Agreement, in order to minimise the Capital Gains Tax liabilities.

These liabilities are often not addressed in standard Shareholders Agreements and Partnership Agreements.

Types of Business Succession Agreement

Click here to read about the alternative types of Agreement.

Alternative IGS Business Succession Agreements

IGS offers a number of alternative Business Succession Agreements:

Simple or Complete Succession Plan

These alternatives give the Business a choice of Agreement, depending on whether it requires a Simple Succession Plan or a Complete Succession Plan.

Click here to read about the difference between the two types of Succession Plan.

IGS can use any one of the Agreements to document a Simple Succession Plan.

However, it uses either a Business Insurance Trust Agreement or a Hybrid Business Insurance Trust Agreement to document a Complete Succession Plan.

Identity of Policy Owner and Trustee

If a Self-Ownership Business Succession Agreement is used, the Policy Owner will be the Life Insured personally.

If a Business Insurance Trust Agreement is used, the Policy Owner will hold the Policies as a Trustee.

The Policy Owner and Trustee is usually the Clients' Business itself or one of the entities within the Business Structure (preferably a Company).

IGS does not use an Institutional Trustee Company.

Click here to read about your choice of Trustee.

A Trustee is not required for the Self-Ownership Business Succession Agreement.

Debt Reduction (or Key Person) Agreement

This is a stripped-down version of the standard Business Insurance Trust Agreement that deals solely with Debt Reduction issues.

It omits the standard Buy/Sell Provisions that form part of the Business Insurance Trust Agreement.

Click here to read about this Agreement.

Fixed Legal Fees

The Fixed Fee charged by IGS depends on the choice of Agreement.

Click here to see the current Fees for all Agreements and Services.

These Fees apply subject to the Legal Fee Policy.

Free 20 Minute Teleconference

If a Client is uncertain whether to attend a Client Meeting or use the IGS Documentation Service, IGS offers a free teleconference (of up to 20 minutes) with the Client to explain the purpose and benefits of a Complete Succession Plan and the "One Page, One Policy Strategy".

Adviser Tip

It is no longer normal for the Business or the Purchasers to own Buy/Sell Insurance, because of the CGT liability with respect to Non-Death Benefits.

See more Adviser Tips

Current Marketing Schedule

Ian Gray travels to most capital cities regularly throughout the year and is available for Meetings.

Please click here to see his availability in Brisbane, Sydney, Melbourne, Adelaide and Perth.

Please contact us to arrange an appointment or teleconference.