Buy and Sell Agreements
A buy and sell arrangement , supported by a buy and sell agreement (Legal Contract) and life insurance (Death and Disability), will ensure that on the death or incapacity of a business owner, the business can continue to operate with as little disruption as possible for the surviving business owner/s, as well as ensuring that the estate of the deceased business owner receives fair value for his/her business interest, as well as settlement of his credit loan account.
Kindly note there are misconceptions between a Buy and sell agreement and Key-man assurance . They are not one and the same in structure and purpose ,regarding the accurate risk profiling of the company or business. A Buy and Sell Agreement is between the surviving partner/s and the executor on the estate of the deceased , who was subsequently bound by the deceased, upon signing the buy and sell agreement. There is a buying and a selling of shares and the transaction is between two persons. Key man assurance is whereby the company insures the life of an individual critical to the income/revenue generation of the business , in order so the company can settle themselves financially and sustain themselves, after the death /disability of the key man until a successor is found.
Why is it important from the surviving business owners’ perspective to have a buy and sell arrangement in place?
- The survivor/s would want to buy the deceased’s interest in the business, but may not have the money readily available to do so. They may need to raise finance, and if they are fortunate enough to be able to do so, interest will be charged on the capital, meaning that over the term they will in fact pay a lot more than the original purchase price for the business interest
- If they are unable to raise the finance then the late co-owner’s spouse or dependants may step into his/her shoes in the business and become a co-owner with the survivors. In many instances this may be highly undesirable.
- If the spouse (or dependants) does become a co-owner, they may not have the necessary knowledge, skill or expertise to be of value in running the business, and will simply be a drain on the business.
- The spouse of the deceased co-owner may demand higher payment for the shares of the deceased that its true value and therefore hold surviving shareholders to “ ransom”
- The survivors may have to pay a “salary” to someone who is not actively contributing to the business, in order to buy that person out of the business over a period of time. This could impact on the long term viability of the business.
- If the trust/corporate entity had to continue to hold the business interest, without making a true contribution to the running of the business, it would still be entitled to share in the profits of the business. This could have a negative impact on the profitability and viability of the business in the long term
- If the deceased co-owner has a credit loan account, this must be settled on his/her death. If there is insufficient liquidity in the business this could pose a very serious problem.
Why is it important from the deceased business owners’ perspective to have a buy and sell arrangement in place?
- The potential capital growth (in terms of the value of the investment in the business) will be left in the hands of the surviving co-owners ability and willingness to continue to run the business profitably, which may not be in the best interest of the trust beneficiaries, who may not have the ability or inclination to be actively involved in the day to day running of the business. The value of the business may well decline and the trust beneficiaries’ entitlement would decline accordingly.
- On death the surviving spouse and/or dependents will have to negotiate a price for the interest in the business, and may not receive a value which in the deceased’s estimation is a fair value.
- The surviving spouse and/or dependants may be compelled to become co-owners of the business. They may not have the ability or the desire to fill your shoes and this would thus be a burden to them.
- The surviving spouse and/or dependants may have to receive the value for their share in the business over a number of years, paid in instalments. If the business does not continue to operate successfully, they will never receive the true value of the deceased’s share in the business, as reflected at the date of death. Their destiny will be tied to that of the business, over which they will have no control.
The structure of the buy and sell arrangement:
The parties enter into a legally binding buy and sell agreement, in terms of which the survivors will be obligated to buy and the deceased estate (or disabled co-owner), or trust/corporate entity, will be obligated to sell his/her/its interest in the business if s/he or the named trustee/director dies or becomes disabled. The current value of the business must be determined by the business’s auditors or accountants and life insurance should be taken out for that value. The parties will own life insurance policies, and pay for them, on each other’s lives or on the life/lives of the relevant trustees/directors, so that they will immediately have the funding necessary to purchase the business interest if one of the co-owners or trustees/directors dies or becomes disabled.
Payment of premiums (No Estate Duty in Namibia / CGT )
The owners of the policy should pay their share of the premium, pro-rata on the life/lives of the other insured partner/s. Payment of the premiums may come from the businesses bank account, or should either be debited to the individual’s loan account.
The Income tax consequences:
The premiums paid for the insurance should not be tax deductible; therefore the proceeds will pay out free of income tax, therefore non-conforming in nature.
Steps to implement a business assurance arrangement:
- Establish the value of the business. It is recommend that the business’s accountants or auditors conduct the valuation in order to ensure that the value is accurate
- Establish the value of any credit loan accounts, if they are to be included in the buy and sell arrangement
- Effect life cover and/or disability cover required in order to purchase the respective business interest in the business.
- It is important to take account of the business owners marital regime as well as trust deeds etc into account when making a proposal in respect of the buy and sell arrangement.
- All the necessary documents to obtain the life insurance with the relevant life office must be completed.
- A formal buy and sell agreement must be drawn up and signed. It is critical that the parties do enter into the buy and sell agreement, as they need both the signed agreement and life insurance in order to have a binding and effective buy and sell arrangement.