The death or disability of a business co-owner can have serious consequences for your business’s ongoing operational ability, making business succession planning an essential component of any company’s future planning. In this article, we provide comprehensive answers to frequently asked questions about buy-and-sell agreements.
What is buy-and-sell assurance and how does it work?
Buy-and-sell assurance is a form of business insurance taken out by co-owners on each other’s lives to ensure business continuity in the event of a partner’s death. Should one of the owners pass away, the policy proceeds provide the surviving partners with sufficient capital to purchase the deceased’s shareholding, thereby protecting the long-term stability of the business. This type of cover can be extended to include disability benefits, depending on the shareholders’ intentions. Importantly, the insurance must be underpinned by a formal buy-and-sell agreement that sets out each party’s rights and obligations in the event of death or disability.
What are the risks of not having a buy-and-sell agreement in place?
For many business owners, their share in the business represents a significant portion of their personal wealth and forms an integral part of their estate. As such, it is essential to protect this value against unforeseen events such as death or permanent disability. If a shareholder becomes disabled or passes away, the remaining shareholders may not have the liquidity to purchase her shares, potentially undermining the value of her estate and the legacy intended for her heirs. Without buy-and-sell cover in place, both the surviving shareholders and the deceased’s estate may face uncertainty around how the shareholding should be managed. This lack of clarity can lead to delays, disputes, and even external interference in the business. Additionally, if the business is forced to use its own working capital to fund a share buy-back, its operational and financial health could be compromised. In light of these risks, buy-and-sell assurance is a vital component of prudent succession planning.
How is a buy-and-sell agreement structured?
Buy-and-sell assurance involves shareholders entering into a formal agreement that obligates the remaining owners to purchase a deceased shareholder’s interest at an agreed value. To fund this transaction, each shareholder takes out life cover on the others. In the event of death, the policy proceeds provide the necessary capital to facilitate the swift and efficient transfer of ownership.
What are the advantages for both shareholders and their families?
A well-structured buy-and-sell agreement offers a range of benefits to business co-owners, the most immediate being peace of mind. It provides certainty that the business can continue to function smoothly should one of the shareholders pass away or become permanently disabled. As a succession planning tool, it ensures that ownership remains within the agreed group of shareholders, protecting the company from unwanted external interference. The agreement creates reciprocal obligations—requiring the deceased shareholder’s estate to sell the shares and the surviving shareholders to buy them—thereby eliminating ambiguity and reducing the potential for conflict. Because the transaction is funded by a life insurance policy, the capital required to purchase the deceased’s shares becomes available quickly and without strain on the business’s liquidity. This allows for a seamless transfer of ownership and ensures that the deceased’s estate receives fair value without delay, safeguarding both the business’s future and the heirs’ financial interests.
How does buy-and-sell assurance affect estate planning?
In terms of the Estate Duty Act, proceeds from domestic life policies that are payable to a deceased estate are generally regarded as deemed property and therefore attract estate duty. However, Section 3(3) of the Act makes specific provision for buy-and-sell policies, provided certain conditions are met. Where the policy was taken out by a co-owner of the business with the clear intention of using the proceeds to purchase the deceased’s shares, and where the deceased did not pay the premiums on their own life, the proceeds will be excluded from the dutiable estate. This exclusion allows for effective estate planning by ensuring that the policy payout is not eroded by estate duty, while still enabling a smooth transfer of shareholding and ensuring that the deceased’s estate receives fair value for the business interest.
How do your dependants benefit from this arrangement?
A key benefit of a buy-and-sell agreement is that it ensures your estate receives fair value for your business interest upon your death. This provides your dependants with the assurance that your financial legacy is preserved. The lump sum they receive from the sale of your shares can be invested to generate income and support their future financial needs.
What provisions should be included in a buy-and-sell agreement?
A buy-and-sell agreement should impose a binding obligation on the surviving shareholders to purchase the deceased’s shares, along with a corresponding obligation on the deceased’s estate to sell. It is important that the agreement sets out either a fixed business valuation or a clearly defined valuation method to avoid disagreements regarding the value of the deceased’s shareholding. Additionally, the agreement should detail how the purchase will be funded—typically through a life assurance policy—and outline the steps required to complete the transaction. For greater certainty, the agreement should also address potential complications, such as the resignation of a shareholder or the simultaneous death of multiple shareholders. A well-drafted agreement ensures that succession unfolds smoothly and that both the business and shareholders’ interests are protected.
What types of benefits can be included in the insurance policy?
Buy-and-sell assurance is typically funded by a whole life policy taken out on each shareholder’s life, with the level of cover aligned to the value of their respective shareholding. Depending on the needs and intentions of the shareholders, the policy may include life cover only, or a combination of life and capital disability cover. Where disability cover is included, it is usually structured as an accelerated benefit, meaning the policy will pay out on either death or permanent disability, providing the necessary funds to facilitate the transfer of shares and ensure business continuity.
Are there any tax consequences to consider?
It is important that the policyholders pay the premiums on the policies in order for the buy-and-sell assurance to be valid, keeping in mind that these premiums are not tax-deductible. On the death or disability of a shareholder, the proceeds will be paid tax-free to the policyholder, who needs to use the proceeds to purchase the deceased’s share in the business. The sale of the shares will, however, attract potential capital gains tax in the estate of the deceased or disabled shareholder.
Buy-and-sell assurance is a vital tool for safeguarding both the continuity of your business and the value of your estate. When correctly structured and supported by a formal agreement, it provides clarity, certainty, and liquidity at a time of potential upheaval. For business owners committed to long-term stability, it forms an essential part of sound succession and estate planning.
Have a wonderful day.
Sue
