For all businesses, it is inevitable that the time will come when there will be a ‘changing of the guard’. But what happens when this is unexpectedly forced upon us?
In the event that a director or key person was to suffer an unexpected departure from the business due to death or disability, there are several important factors that every business needs to consider.
For the purpose of this article we will assume ABC Pty Ltd has 3 directors, Allan, Bart,and Cindy, and director Allan has recently passed away unexpectedly.
Upon Allan’s death, his equity within ABC Pty Ltd, has passed directly to his estate, and Bart & Cindy are now in partnership with Allan’s estate (which will ultimately pass to Allan’s widow Anne). Some key considerations need to be addressed as to what will happen going forward with the business:
1) Anne may not have the skills or desire to actively work in the business, however may still wish to draw a director’s fee for being a shareholder. Bart and Cindy would continue to run the business, effectively covering Allan’s now vacant role.
2) Anne may wish to assume Allan’s role within the business, for which she has no previous experience or knowledge, and want to have equal input into the management of the business with Bart & Cindy.
3) Anne may be happy to sell her equity to Bart & Cindy, however due to the loss of Allan from the business, Bart and Cindy may not have the capacity to borrow additional funding to complete the purchase.
Without prior agreements and a properly documented Business Succession Plan, there is no certainty to any party.
A properly documented Business Succession plan would enable all directors, Allan, Bart and Cindy to establish and agree a strategy that would see Allan’s equity in ABC Pty Ltd passed to Bart & Cindy for a pre‐agreed price, allowing Bart & Cindy to continue the business without the additional stress of dealing with Anne.
In return, Allan can be guaranteed a set price from the sale of the business to leave to Anne so she can continue to live her life without the hassle of dealing with the sale of equity in a business that she has little to no understanding of or interest in.
In our example of ABC Pty Ltd, we understand that the business carries total business debt of $600,000, with each director providing a personal guarantee and Allan using his principle place of residence as security for the loan. In addition, when we look to the financial accounts for the business, we understand that Allan has a director’s loan, showing that ABC Pty Ltd owes him $75,000. Assuming that Allan has now passed away, it is important to remember that the
obligation to repay the loan has not ceased.
Regardless of whether or not the equity within the business has been sold, the directors need to work out how to release Allan’s estate from security for the business loans. This will generally come down to 2 options for the surviving directors, either provide security suitable for the financiers to release Anne’s home from security, or pay down part or all of the debt. This may become a large, unexpected burden on the cash flow of the business.
In addition, Anne may wish to call the debt of $75,000 owed to her from the business.
Without people, it is hard for a business to continue. Some businesses depend on some people more than others. In our example of ABC Pty Ltd and Allan’s death, the business can be faced with a number of issues that need to be considered. As Allan was the head of sales, his role was important as he was seen as the face of the business and held the relationships
with the customers. The surviving business owners will need to meet the cost of recruitment to replace Allan. Some recruitment costs can become expensive with executive recruitment expenses up to 30% of overall package.
In addition, the business may suffer a decline in sales, given the loss of Allan. How will a business survive these times and what plans can be put in place to try to insulate the businesses profits and capital needs to replace Allan?
Infocus and Riba Business Lawyers Can Help!
We can help identify the possible issues and various solutions and guide your business and its directors to implementing a strategy best suited to your needs.
There are several options available to deal with the issues highlighted above. The important factor is for all 3 directors to meet, discuss and review all of these options and agree on a strategy most suitable to the needs of the business and its directors.
A properly constructed Business Succession Plan doesn’t just happen. It is a complex set of strategies designed to ensure the continuity of the business, and to transition equity in the event of death or disability of one or more directors of a business.
Having extensive experience in dealing with Business Succession Planning, Infocus can help your business simplify, and most importantly, understand each of the areas that need to be addressed. Infocus can offer suggestions and alternatives to suit your particular needs and desired outcomes.
Once you have agreed on a plan, Riba Business Lawyers and Infocus will assist in helping make sure that all appropriate documentation and strategies are executed correctly, and will coordinate the process to ensure that you have certainty and peace of mind.
This Article Contributed by Luke Jensen Senior Financial Adviser Infocus