A person protects his personal wealth or estate by writing a Will. Similarly, a business owner who wants to ensure his business is protected against unforeseen or unfortunate circumstances, for example death, critical illness, bankruptcy or total permanent disability (TPD) can create a Business Value Protection Trust (BVPT). Having a BVPT also protects the interest of the other business co-owners.
A BVPT ensures a proper exit strategy is in placed for a business owner. It ensures his business value is protected and the continuation or smooth transition of the business interest to the other co-owners.
Important issues to address
If something happens to a business owner (e.g. untimely death or TPD), various issues arise that have to be addressed.
* Inheritance by heirs
When a business owner dies, his share of the business interest will be passed on to his heirs who may or may not be interested in the business.
* Difficulty in selling the business interest
The business share of a private limited company must first be offered to the existing shareholders for purchase before it is offered to a third party. The heirs who inherited the business may also end up selling the business share at an undervalued price as they are not knowledgeable of the real value of the business.
* Financial difficulty for the family
The deceased business owner’s family will need to settle all existing debts and meet other financial obligations such as living expenses, medical and education expenses. If the business owner is critically ill or suffers from TPD, the family has to cover all the medical treatments required.
* Serious disruptions to the business
When a business owner passed away and his business interest or share goes to his heirs, the business may be disrupted. For example, the unqualified heirs may wish to get involve in the business or may even dispose the business share to a competitor.
* Closure of the business
Closing down the business may be the recourse taken by the surviving business owners if the existing business is disrupted too much. For example, the inexperienced heirs want to participate in running the business and causing complications to the other business owners.
Benefits of having a Business Value Protection Plan
The main advantages of having a Business Value Protection Plan are
* Guarantees full and fair value
The business share or interest can be sold at a fair price agreed upon by all parties. Unqualified heirs are prevented from disrupting the business and also avoids the disposal of the business share to other parties.
* Pre-agreed pricing
The price is pre-agreed upon by all parties and averts problems later on between the surviving business owners and the heirs.
* Quick and smooth transfer
All parties are protected including the deceased business owner and the surviving co-owners with the implementation of a Trust Deed. Having a plan ensures a smooth and efficient transfer of the business to the co-owners. Major disruption to the business can therefore be avoided.
* Conversion to liquid income
The non-liquid stock/interest is converted into liquid income ensuring funds are available to the outgoing business owner or his loved ones (as contained in the Trust Deed).
* Independent referee to execute the necessary transfers
The appointed Trustee is responsible to ensure that the outgoing business owner’s interest is transferred to the surviving business owners as well as the proper distribution of the sale proceeds.
* No disruption to the existing business
The business continues to run smoothly with no major interruption or interference providing reassurances to everyone concern, for example the suppliers or creditors as well as key employees.
* Prevent wastage of the sale proceeds
Each business owner leaves specific instructions in the Trust Deed that instructs the Trustee on the proper distribution of the sale proceeds and to ensure that the beneficiaries do not misspent the sale proceeds.
It is obvious that having a Business Value Protection plan gives all parties concern the peace of mind to conduct business together without worries should anything happen to one partner. Now, let’s look at the relevant documents essential to creating a Business Value Protection plan, the trigger events and the insurance policies.
The important documents required in a Business Value Protection plan are
* Buy-Sell Agreement or Cross Option Agreement
The terms and condition of the sale are stated clearly in the agreement as well as the share value of each party, the specific events triggering the buy-sell and the funding for purchasing the business interest (life insurance and cash).
* Irrevocable Power of Attorney by each business owner
This enables the Trustee to act upon the written instructions to transfer documents of the outgoing business owner to the surviving business owners.
* Trust Deed
The Trustee will distribute the sale proceeds of the share to the Trust Beneficiaries named in the Trust Deed.
* Life Insurance
This is used to fund the purchase of shares of the outgoing business owner.
The trigger events such as death, total permanent disability (TPD), retirement (optional) and critical illness (optional) must be clearly defined. These events will trigger the sale and purchase of the business interest. The business owners concerned must determine which event shall be used to trigger the buy-sell of the business interest. The events with exception to retirement must be the same as stated in the insurance policies to trigger a claim.
The business owners are required to purchase first party insurance policies on their own lives and from the same insurance company. This ensures consistency especially in the definition of events triggering an insurance claim. The sum assured should be proportional to the value of their individual business interest.
The payments of the insurance premium can be made through the dividends to the shareholders or the Director’s fee if the shareholder is one of the Directors or it can be made by the individual business owners. All the insurance policies are assigned to the Trustee to ensure a smooth process where the insurance proceeds are used to settle the sale and purchase price of the outgoing business owner’s interest and to distribute the proceeds to the Trust Beneficiaries.
Business Value Protection Scheme
Below is schematic flowchart that illustrates the idea of a Business Value Protection plan, provided by Rockwills.