WHY HAVE A BUY/SELL DEED?
A Buy/Sell Deed is an agreement between the owners of a company or unit trust that upon the death or permanent disablement of a director or key person associated with a shareholder/unitholder, that shareholder/unitholder must transfer its shares to the remaining shareholders in exchange for payment.
The method of determining the price is agreed and the funding of that payment usually comes from the proceeds of insurance policies to be taken out for those risks by the shareholders/unitholders.
A Buy/Sell Agreement is not a general Shareholders Agreement or Unitholders Agreement so it does not regulate all dealings in relation to the company.
COMMON SCENARIOS A BUY/SELL COULD HELP PREVENT
Consider the following and how it may affect you and your company:
- A shareholder dies and you as the remaining shareholder inherit an unintended (and potentially non-income producing) business partner such as the deceased shareholder’s spouse (as they receive the deceased’s assets via their Will), with company profits being paid out according to the shareholdings.
- You have to buy shares from a deceased shareholder’s estate above their value.
- Your family do not get the best price for your shares in the company.
- The remaining shareholders don’t have available funds to pay out a deceased shareholder or a shareholder who can no longer contribute to the business due to total and permanent disability.
- The business either needs to be sold or funds need to be borrowed by the remaining shareholders or the company to make the payments.
- A key person to the company has died, leaving the company in the position of losing a key source of revenue, client relationships and knowhow, affecting the value of the company and its business and its viability in the future.
CERTAINTY
A Buy/Sell Agreement is designed to bring certainty in relation to the exit from a business as the result of death or permanent disability of a key person – certainty for an ill shareholder, a deceased shareholder’s family, the remaining owners and the company itself. Don’t leave it to chance.
HOW DOES A BUY/SELL AGREEMENT WORK
A buy-sell agreement is an agreement which by means of put and call options, binds the continuing owners of a business to purchase a departing owner’s interest on the happening of a specific event. The events that trigger the buy-sell agreement are commonly the death or the total and permanent disablement of one of the owners.
The buy-sell agreement works in either of the following ways:
- where by exercising a call option, the continuing owners force the departing owner or his/her legal representatives to sell his/her interest to the continuing owners
- where by exercising a put option, the departing owner or his/her legal representatives compel the continuing owners to purchase the departing owner’s interest
The agreement may be drafted in a way that applies to any business structure such as a partnership, a unit trust or a proprietary company.
Generally, the buy-sell agreement is fully funded by the proceeds of a life insurance policy providing for the departing owner or his estate to be paid an amount equivalent to the departing owner’s interest in the business in the event of his/her death or total and permanent disablement.
In the case of a business carried on by a corporate entity, a buy-sell agreement may take the form of a cross-purchase agreement, where the continuing owners purchase the shares of the departing owner or a redemption agreement, where the company buys back and cancels the departing owner’s shares or in the event that the proceeds of the insurance policy are insufficient to meet the full purchase price of the departing owner’s shares, a hybrid cross-purchase/redemption agreement, where the company buys back and cancels any remaining shares not purchased by the continuing owner.
OWNERSHIP OF THE INSURANCE POLICIES AND TAXATION
Depending on the business structure and the manner in which the buy-sell agreement operates, the insurance policies may be self-owned by the owners or taken out over the lives of the other owners or they may be owned by the company or by a trustee of a superannuation fund. In the case of a corporate entity, the buy-sell agreement may provide that the company pays the insurance premiums.
The ownership of the insurance policies and payment of the insurance proceeds on the occurrence of a triggering event will raise various taxation issues including:
- whether upon the death of a owner, the payment of the proceeds of the insurance policy to a nominated beneficiary is exempt from capital gains tax;
- whether the payment of total and permanent disability benefits under the insurance policy to a departing owner is subject to capital gains tax. If so, it may be necessary to ensure that the net insurance proceeds are sufficient to fund the purchase of the shares and to meet any potential tax liability;
- the buy-sell agreement may provide that where the insurance proceeds are paid to the departing owner or his/her nominated beneficiary, the purchase price of the shares is reduced by the amount of the payment and the shares of the departing owner are transferred to the continuing owner for nominal consideration. If the ATO were to take the view that the continuing owner acquired the shares for no value, the continuing owner will potentially have a capital gains tax liability, if he/she later disposes of the shares;
- deductibility of the insurance premiums.
HOW CAN NB COMMERCIAL LAW HELP
NB Commercial can provide owners of a business with advice as to the most appropriate arrangements for their particular circumstances before entering into a buy-sell agreement.
For a no obligation consultation, please contact us on (07) 3876 5111 or [email protected].