Protect the value you built up in your business
Laura du Preez: What will happen to your precious company if you die or become disabled?
The many hours you as a small-business owner spend on your businesses will have you believing it is a valuable asset.
But a business is worth nothing if its value can't be realised when you are no longer able to run it.
If you are your business's most valuable asset, you need to protect the value you have built up in it from the consequences of your death or disability.
Business owners often assume that there will always be a buyer for their business, when in fact owner-managed businesses are notoriously difficult to sell at a fair price, should the need arise after your death or disability, says Peter Harten, a certified financial planner at BDO Wealth Advisers.
You have a better chance of securing a fair value for the business if you negotiate upfront with potential buyers how the business will be valued should it need to be sold, he says.
Another misconception is that when a business has shareholders, they will always act in the best interests of the other shareholders.
But if you are disabled and decide to sell your shares, you may find your influence over other shareholders diminished - and they may be less inclined to support you or pay a fair price for your shares, Harten says.
And if you die, your heirs may find themselves unable to work in the business or to negotiate successfully with the surviving shareholders.
Harten says it is for this reason that business owners should draw up buy-and-sell agreements that set out how the business will be valued and who will buy it, or your share, from you or your estate.
If shareholders or an outsider who agrees to buy your business, or a share of it, do not have the capital to buy it, they can structure the agreement to pay off what they owe or take out life assurance on your life to pay out the purchase price.
Jenny Gordon, a senior legal adviser at retirement, investment, life and insurance consultant Alexander Forbes, says the benefit of this cover is that your family can inherit the value of your share of the business as soon as your estate is wound up, and the co-owners of the business can continue to trade without being constrained by having to find the funds to buy your interest or having unskilled family members interfering in the running of the business.
This life cover - known as a buy-and-sell assurance - should be owned by shareholders or others who have agreed to buy your share of the business.
Sherwin Govender, a business development manager at Glacier Financial Solutions, told a recent webinar for members of the Financial Planning Institute that he has seen many cases where business owners have buy-and-sell assurance but no buy-and-sell agreement determining what will be sold to whom and at what price.
A properly structured agreement should be in place first, possibly with life cover, to eliminate uncertainty for your heirs and fellow shareholders, and to convert your business equity into cash, he says.
Harten warns against insuring your own life and making the other shareholders the beneficiaries of the policy or ceding the policy or policies to them. Doing this would result in the value of the policy as well as the proceeds of the sale of your shares being included in your estate when you die.
Govender says that to ensure that the buy-and-sell life assurance is exempt from estate duty, the policy must be taken out by the other shareholder or buyer specifically to buy the shares in the business, and the business owner must not have paid any of the premiums.
Harten says that only if you think your business will close when you die or become disabled should you insure your own life, which will ensure that your dependants are covered for the loss of your ability to earn an income.
Buy-and-sell cover, however, will pay out to the person or persons who have agreed to buy your share of the business.
The cover does not belong to you, the business owner, and you cannot state what will happen to the proceeds in your will.
You can only direct in your will how the proceeds of your shares should be distributed.
You should also not try to set the value of your business in your will - the buy-and-sell agreement is the document for that, Harten says.
He suggests that your shareholder agreements or buy-and-sell agreements are reviewed by a legal adviser who also looks at your will to ensure there are no conflicting provisions.
Govender says it is important to monitor that the cover is aligned to the value of the business.
If the cover exceeds the value of the business, there could be donations tax implications.
A business can also take out key-man insurance on an owner - or even on someone who is not a shareholder but who is crucial to the business - to cover it from the losses it may suffer if you as the key person in the business die or are disabled.
This policy is owned by the business and the proceeds are paid out to it.
Says Gordon: "A key person might not be a co-owner but might be a particular employee who has skills and knowledge and relationships with suppliers and clients, which would cause great loss to the business if he or she died or became disabled."
You risk losing it all with no succession planning
Working for four years with his dad in a strong R40-million business was not enough to ensure Jake* was able to keep the business on track, and now it is struggling to stay afloat.
Jake, 28, was still learning about the management of the business and did not have the close relationships with the suppliers his 60-year-old dad had before he died, Old Mutual Wealth Legal Adviser Daleen Harris says.
The suppliers and his dad were contemporaries and operated on the basis of a handshake.
Jake wants to contract with the suppliers, but they now feel their word is not good enough, she says.
It took him almost four weeks to take over the business bank account after his dad died, during which time the business almost came to a standstill.
He also had to take over the surety his dad had signed for the R5-million overdraft on the business account.
As Jake's dad believed his son was his succession plan, he did not take out any cover for overdrafts; neither did he ensure some cash flow for a rainy day, which would have prevented Jake from facing such a tough time, Harris says.
Can't settle debts
In another case, businessman Joe* had a R10-million business renting out storage units in Midrand and earning an income of about R90000 a month.
In his will Joe left cash and assets to various people.
The residue of his estate, which included the business's premises, was bequeathed to his son, Harris says.
When he died, his administration costs and liabilities, including the property transfer, executors' fees, estate duty, capital gains tax and income tax, amounted to close to R2.6-million, but there was only R400000 in cash in the estate to settle the debts. Joe's son does not have the means to pay the R2.6-million to retain the property and the bank does not want to provide him with a loan as he does not have sufficient assets to use as security.
Joe's son does not want to sell the property as it has a good location and the business provides a great income.
The executors of the estate were not prepared to let Joe's son pay for the transfer of the property into his name and then take out a bond to settle the debts.
Joe's lack of estate and succession planning means his son now faces losing the business for which Joe worked very hard, Harris says.
In a third case, a poorly drafted buy-and-sell agreement has left the husband of business owner Cynthia* with a mess after she died.
The company had six shareholders, two of whom held 40% of the company each and the remaining four held 5% each.
Although the agreement provided for the surviving shareholders to purchase the shares of a deceased shareholder, it failed to say how they would pay for the shares or how these would be valued.
BDO Wealth adviser Peter Harten suggested that Cynthia*, a business owner, get a lawyer to fix the agreement and that each partner take out insurance on the other shareholders' lives.
Cynthia had taken out R1-million of life cover on her own life and made her husband the beneficiary.
The shareholders demanded the R1-million be paid to the partners to buy his share, but Harten advised him not to pay it over.
The "sorry saga" ended with the com-pany going into liquidation after sureties for loans to the business were called in by the bank.
The shares were worth nothing. Cynthia's husband received the R1-million life cover but her lack of planning resulted in him realising no value from his wife's share in the business, Harten says.
*Not their real names.