Many business owners plan every detail of a new business venture but overlook one crucial aspect: exit and succession. What happens if one of the business owners wants to exit voluntarily? What happens if they become too sick to continue to participate or they were to die unexpectedly?
As a business owner, it is crucial to prepare for these scenarios as they will be inevitably faced during the life of the business.
What is a Succession Plan?
A succession plan prepares business owners for the voluntary or involuntary departure from the business of a key business owner. In many cases of family businesses, this involves implementing mechanisms for new generations to smoothly assume control of the management and operation of the business.
A succession plan documents and facilitates the transfer procedures on the departure of a business principal quickly and effectively so that the business can continue to operate in a means that preserves the value of the business for all of the continuing business participants.
There are two exit scenarios of a business principal that every business owner should plan for:
- Voluntary Exit (e.g. retirement, change of plans). This event is typically dealt with in the shareholders or unitholders agreement entered into by the business principals when determining the business structuring. However, if the existing shareholders or unitholders agreement does not deal with this scenario, then a new Equity Holders agreement may have to be prepared.
- Involuntary Exit (e.g. death or illness). These scenarios are typically dealt with in a buy/sell agreement.
What is a Buy/Sell Agreement?
A Buy/Sell agreement documents procedures regarding the involuntary departure from the business and the transfer of exiting the business principal’s equity in the business to the continuing principals. Insurance policies should be used to underpin the agreement and fund the transfer of the equity of the exiting business principal.
In addition to setting out the procedure on how the transfer of equity is to occur, the terms of the buy/sell agreement should also set out the procedure regarding how the equity of the exiting business principal is to be valued, and what is to occur if there is a deficit or a surplus of insurance proceeds.
Benefits of having a Succession Plan:
- The provision of clarity to business principals, future equity participants and their respective legal personal representatives should ;
- The minimisation of uncertainty regarding the ongoing operation of the business;
- Reducing the level of the exposure of the equity participants (both exiting and continuing) to debt; and
- Providing funds for the transfer of the ownership interest of the affected principal thereby enabling the connection of the family of the deceased business principal to be severed if that is the desired outcome.