Why Shareholders Agreements accompanied by Buy/Sell Insurance, and an Independent Business Valuation are so Important

​If you are in a business partnership - have you considered what would happen to the ownership you hold in your business, if something was to happen to you or your business partner/s?

Have you thought about running the business with your partner’s family if the partner is no longer here, or capable?

We have heard many times that “if my partner died, there’s no way I would want to have to deal with their husband/wife telling me how to run my business!”

So how do we avoid this problem? Here’s a case study to show you how it can be done.

Background

A successful and well-regarded mid-sized construction company (“Colossal Constructions Pty Ltd”) is led by a board of four Directors, who are all also shareholders in the business – holding 25% each via their family trusts.

The board consisted of:

• Pete Smith;
• Helena Carter (Peter’s sister);
• Barry Crocker (Peter’s best mate); and
• Cathy Freely (Barry’s sister)

Each shareholder has their own spouse and children.

Their business Adviser understood the complexities of multiple family shareholders, and suggested the business have a Shareholders Agreement prepared, backed by holding Buy/Sell Insurance for all Directors. This would enable the business and/or the remaining shareholders to fund the purchase of a Director’s shares in the event of death, serious medical condition or disability.

They may be related or best of friends, but when it comes to a serious event and money…well, well all know what often happens!

Situation Analysis

A properly written Shareholders Agreement dictates what is to happen in such an event, this may be that:

• The business buys back the shares of a partner; or
• All or some of the partners take up the purchase of that share.

But, if something happened to Pete, do Helena, Barry and Cathy have the funds to buy back Pete’s shares? Can they all afford this?

The Buy/Sell Insurance policy is put in place to enable a payout on the occurrence of an event, to enable the Director’s family to be fairly compensated, and bought out of Colossal Constructions Pty Ltd.

To ensure appropriate insurance cover was maintained over time, the Directors tasked the Adviser to monitor the value of the business, and therefore each shareholder’s true value, on an ongoing basis.

On one hand, the Directors would require a responsible valuation to help manage the cost of the insurance policy, while on the other hand, ensuring the family of a deceased Director that the value is a true and fair value because they may feel their father/mother’s shareholding should be worth more!

Given the complexities of multiple families involved in the business, the Adviser makes detailed recommendations to Pete, Helena, Barry and Cathy that an independent external valuation, updated on a regular basis, would be necessary. As the company was of a relatively significant size, the Adviser also regularly prepared cash flow forecasts and budgets to a high level. The quality of the information the Adviser could provide would allow the valuer to confidently apply a methodology designed to assess both historical results and forecast expectations.

Outcome

Pete, Helena, Barry and Cathy all agreed to Colossal Constructions Pty Ltd being valued on an annual basis, especially once consideration was given of the need to avoid disputes if it became necessary to pay out the shareholding of a Director’s family in the event of sudden death or incapacitation.

The regular independently obtained valuation reports also addressed the need to determine the value of the goodwill enjoyed by Colossal Constructions Pty Ltd. The professionally compiled valuation report included a figure for goodwill which could be brought to account on the company’s Balance Sheet, thereby satisfying the business’s auditors.

It also allowed for the insurance policies to be updated to reflect a true and fair payout value and protect all shareholders.

In Summary

While your business may not be as big as Colossal Constructions Pty Ltd, if you have more than one shareholder, have you thought about what would happen in the event of death or incapacity of your business partner?

This may be:

• Your brother or sister;
• A best mate/s; or
• A group of like-minded partners

that each have their own family - and you don’t want to be in business with their spouse and/or family if something were to happen.

Many successful businesses have fallen apart because of such an unfortunate event, and the business partners never planned and put steps in place – because “that would never happen” to them!