Your business partner’s death is probably the last thing you think of when you start in business together.
However, it is generally believed that one of the key aspects of starting a business is planning for when you leave the business.
Most people expect to leave a business they own either when they retire, or when they sell their share to move on to another venture.
While most businesses end with the existing business owners still alive, that is not always the case. While most people live beyond the usual age of retirement, it is a fact that some do not, and some of those who do pass away at a younger age will be business owners.
Normally when a business owner decides to leave a business, they part own, they will sell their share of the business to one or all the remaining business owners, or with the other partner’s agreement, they may find someone else to buy their shares off them.
Some sort of valuation formula will be agreed upon so that a fair price is struck. One of the problems facing business partners is how to fairly evaluate the worth of the business. Disagreements often arise when the selling partner believes the business is worth more than the other partners who are interested in buying his shares are willing to pay. One of the fairest ways to resolve differences in the worth of the business is to have the business valued by a Certified Valuation Analyst with the National Association of Certified Valuators and Analysts (NACVA). This removes the partners with differing interests in the transaction from determining the value of the business and puts it in the hands not only of a neutral party, but one who has been certified to determine the fair worth of a business.
Once the value of the business has been ascertained in manner fair to all, the departing business owner walks away from the business with a fair monetary exchange for the value of their share of the business.
In the event of a business partner dies, the outcome should be almost the same.
It is unlikely that a new owner has been sitting waiting for one of the business owners to die, so it is more likely that the deceased’s share of the business should go in equal shares to the remaining business owners.
The valuation formula will then pay for these shares to the estate of the deceased.
No, not always.
Just as the death had probably been unexpected, the need to front up with the money to buy the deceased’s shares is equally unexpected for each of the remaining business partners.
Let’s assume there are five business partners, each owning 20% of the business.
When one partner dies the remaining business partners must each buy 5% of the value of the business and pay this to the deceased’s estate.
What if three of the remaining partners can’t afford to buy the shares at the time of death. But the other partner can afford to buy the full 20%.
That partner now owns 40% of the company and the other three partners only own 20% each. The previously even ownership status of the business has now changed markedly. Decisions over the future of the business will have a far greater effect on one business owner much more than the others.
The solution is reasonably simple and includes three steps and the purchase of life insurance policies to fund the transfer of ownership and the payment of a fair value to the heirs of the deceased partner.
1) A formula is created on how to value the shares at any time and the value of shares is reviewed at least annually – everyone knows what the fair value price of each share in the business is worth.
2) A formal (and legal) agreement is signed by all business owners that in the event of the death or permanent departure of any single business owner, the remaining four partners commit to paying the departing business owner – or their estate – their 20% ownership (5% each) of the business, based on the valuation formula.
3) A Life Insurance policy is taken out on the life of each of the five business owners for the current value of a 20% share of the business. The value of the Life Insurance cover is adjusted each year to remain the same as the current business valuation.
Each Life Insurance policy is owned equally by the four other business owners.
With this plan in place, if a business owner dies, the remaining four business owners have agreed to buy the deceased’s shares off the deceased’s estate, at an agreed price. The Life Insurance policy ensures the right amount of money is received by each of the remaining business owners at the right time. The agreement commits them to pay that money to the deceased’s estate. The deceased’s estate is committed to selling the shares at that agreed price.
This plan keeps everyone happy (in financial terms) upon the death of any of the business owners, at the time of death, and into the future. It also avoids the complication of the four remaining business owners being forced into business with the deceased’s estate or their spouse, who most likely can provide no positive input into the business but would naturally want a maximum income from the business.
Instead, the deceased’s estate has been paid a fair price for the deceased’s shares, the remaining owners have each gained an extra 5% ownership in the business at no cost to themselves, and the balance of the ownership of the business has remained the same.
If you want to know how to plan for the transfer of shares when one partner dies, contact Corporate Business Solutions for a confidential consultation. You can find more helpful information by consulting Corporate Business Solutions Reviews.