The importance of business succession planning What happens to a business if its owner or co-owner dies or falls seriously ill? Much will depend on the type of business – sole trader, partnership or limited company – but unless there has been some advance planning, the chances are that there will be disruption, arguments and the strong possibility that all or part of the business will end up in the wrong hands.
So if you’re a business owner, business succession planning and insurance is important. It’s quite simply the process of planning for what you want to happen if you (or your co-owner, if you have one) were to die or fall seriously ill.
The legal position on the death of a business owner will depend on the type of business entity.
When a sole trader dies, their business dies with them, legally speaking. The business’s assets will form part of the sole owner’s estate and pass on to beneficiaries under the terms of their will. If the owner has not made a will, the intestacy rules apply; in effect, the state lays down who the estate should pass to, and normal inheritance tax (IHT) rules apply.
However, the good news is that most trading businesses are not subject to IHT – if you’re unsure about yours, you should certainly take advice. If your business does not enjoy tax relief, the basic requirement is to create a capital sum, preferably outside the estate, in order to minimise IHT.
This could be achieved with the help of a suitable life insurance policy.
A partnership is a business owned by at least two people. Unless there’s some specific provision in the partnership agreement (and very many partnerships have no formal agreement), a partnership ceases when a partner dies. When that happens, the deceased partner’s estate becomes entitled to their share of the business.
This can mean a choice for the surviving partner or partners. They could pay the deceased partner’s estate a sum of money they all agree to be the value of the deceased partner’s share, or carry on in business together with the deceased partner’s spouse or other beneficiary – even if the new partner has little to contribute to the success of the business.
Effective succession planning provides some clarity in the event of death. A double option agreement ensures the surviving partner(s) has the option to buy the share in the business from the deceased partner’s estate. The deceased partner’s estate can also exercise an option to force the surviving partner to buy. Under an automatic accrual arrangement, the surviving partner(s) inherits the business, but the family receives the proceeds of a life policy.
There may also be a need to insure the lives of all the partners to cover potential liabilities that might arise on their death – perhaps to pay off an overdraft or other creditors.
Limited companies continue after a shareholder’s death, but the basic succession issues are similar to those facing a partnership. The key is to make sure that the shares end up with the surviving shareholders and the deceased shareholder’s family receives some money.
Generally, the deceased shareholder’s beneficiaries will want financial compensation in return for their shares, assuming that they don’t plan to continue in the business; and there may also be the need to pay off creditors on an owner-director’s death.
A double, or cross, option agreement is often used for company shareholder succession planning. If a shareholder dies, their beneficiaries can require the remaining shareholders to buy them out or the remaining shareholders can require the beneficiaries to sell their shares.
To provide the funds, each shareholder should take out an ‘own life’ policy written under a special business trust to benefit the other shareholders.
Of course, it’s not just the death of a business owner that can stop a business. If a business owner suffers a critical illness, such as a heart attack or cancer, it may not be possible to continue in the business either temporarily or permanently.
Expert advice, taken before the event, could have helped in both of these cases. A suitable critical illness insurance policy is probably the best way to provide protection against the financial consequences of having a serious illness. These policies pay a cash lump sum on diagnosis of a specified critical illness or disability.
The policies are normally written in trust for the other business owners, along with an agreement between the business owners about the circumstances in which the share in the business should be transferred.
The death or critical illness of a business owner can lead to unexpected or undesirable consequences for those left behind. Taking the opportunity – well in advance of such an event happening – to plan for such a situation can help crystallise what you want to happen to your business after your death, and to identify how best to ensure that this will actually come about.
A good adviser will start by finding out the most important issues of their business owner clients and, once these have been identified and prioritised, they’ll recommend a suitable way forward.
To receive a complimentary guide covering Wealth Management, Retirement planning or Inheritance Tax planning, produced by St. James’s Place Wealth Management, contact Charlotte Poole-Graham on 07415855071, by email firstname.lastname@example.org or visit www.charlottepoolegraham.co.uk
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