The premature death, disablement or long-term serious illness of a business partner is one of the most overlooked but preventable business risks I see business owners take time and again.
Let’s set the scene: you and your partner/s are running a great business, you’re making money, you get on well enough and you have big plans for the future. You have overheads, stock and loans but overall, you have gone from success to success and you split the workload, decision making and responsibilities with your partner/s equally.
Then, out of nowhere your business partner (let’s call him Fred) has a heart attack driving home from work. Fred is rushed to hospital and despite the best efforts from everyone working at the hospital that evening, Fred tragically passes away, leaving a wife and three kids who are all school aged behind.
You and Fred have been putting everything into the business and whilst you both have some personal assets, there is no doubt that the business is the biggest asset and source of income for you both – so what happens now?
Well, if you haven’t got a buy/sell agreement in place, you will have a limited amount of control over what happens next, but fundamentally, there are only a few options available.
Option #1 – Work Twice As Hard: You can pick up the slack of Fred’s half of the work, responsibilities and decisions whilst his family continue to be provided with their entitled share of the profits and assets. This may not be an option as Fred’s wife may want to sell her share of the company to access capital, however.
Option #2 – Take On More Debt: Ok, you have decided that the workload is going to be tough but doable. You might not get as much time with your own family but you know that your business is going to be great so you come up with a fair figure to pay to Fred’s family and you go to bank looking for a loan. The bank is happy to provide you with this credit but you are going to have to put your family home up as security and take out an unsecured line of credit for the outstanding amount. The interest bill is high and all of a sudden you are taking a huge amount of risk. Sure, the reward is great, but what happens if things don’t go as well as planned?
Option #3 – Take On A New Partner: You have realised that the risk is huge and you don’t want to put the family home on the line (it has taken you 10 years of hard work to pay it off). You have discussed it with your family and decided that the best thing to do is to bring on a new partner. One problem though, who is going to dive in with you and what if they have no idea what they’re doing? What if you can’t stand working with them after a few months?
Option #4 – Sell everything: As much as you wish it wasn’t so, you can’t stand the idea of option 1, 2 or 3 so you decide that you are going to sell the business and all the stock. You approach a business broker to try and find a new buyer. After 12 months you finally find someone (all this time you have been basically doing option 1 anyway). They purchase your business and you walk away with a bit of money in your pocket as well as an obligation to work in your business for the next 6-12 months during a ‘handover period’.
So, what is the way to avoid all the heartache, stress and financial risk or loss?
The easiest way to prepare for the unplanned exit of a partner from a business is to have a rock solid buy/sell agreement (BSA) with buy/sell cover in place which insures against the event of early death, disablement and serious illness of a business partner. This should be reviewed every two years to make sure that it is still relevant and cost effective.
What are the benefits of having buy/sell cover in place?
Each of these structures have their own benefits and potential disadvantages, so it is really important that you speak with a professional who understands these structures to make sure that your buy/sell cover is cash flow effective, tax efficient and is going to be accessible after claim.
You will need to work out how much cover is appropriate in each situation. An adviser who works in this area should be able to help you work out how much cover you will need based on EBITA and goodwill.
It is crucial that your buy/sell cover is underpinned by a legally enforceable buy/sell agreement. We recommend that you introduce your financial adviser to your lawyer so they can collaborate and agree on a correct structure that works for your business.
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