Buy & sell agreements: How they can help ensure the survival of your business

22 June, 2015 | Peter Smith

What would happen to your business if the worst suddenly happened to one of the owners?

It’s certainly not a pleasant thought, but it is a scenario that could have serious ramifications for those left behind. Fortunately there are plans you can put in place now to help the business through such a time.

Agreements commonly known as ‘buy sell agreements’ set out the arrangements between shareholders in a privately owned company, for one shareholder to buy the other out in the event of death, serious long-term illness or accident.

There are specialised insurance brokers who develop insurance products to underpin buy sell agreements so as to ensure that the funds are available should an event as described above occur.

There are ordinarily two types of insurance:

Key Person Insurance

‘Key person insurance’ is owned by the business and enables the business to cover the cost of replacing the exiting shareholder should an event occur. In such circumstances, a business will suffer loss of turnover and expertise and will need to restructure and find a new employee or employees with the required level of expertise.

The costs of replacing the turnover, restructuring and hiring new employees will all be faced by the business and it is these costs that are mitigated with key person insurance. The premiums of a key person insurance policy are tax deductible. The proceeds of any insurance claim under a key person policy are taxable.

Buy Sell Policies

These policies are normally held by a trustee for the shareholders and cover the events such as death, serious permanent injury and ill health that cause a working shareholder to have to retire from the business. It is the buy sell insurance policies that provide the funds to enable the surviving shareholders to purchase the shares and current account of a deceased or permanently incapacitated shareholder.

The amount of buy sell insurance that is purchased by the shareholders will depend on several variables:

• Cost of the premiums – these must be affordable.
• The age and state of health of the shareholders.
• The type of business and the ability to finance the purchase of a deceased or incapacitated shareholder’s shares, compared to the cost over time of the insurance premiums.

The premiums of buy sell insurance are not tax deductible and the proceeds of any claim are not taxable. Companies or businesses can pay the premiums on buy sell insurance, however the payments have to be debited to the individual shareholder’s current accounts in the business and not to the profit and loss account of the business.
Specialist insurance brokers can provide buy sell insurance products that balance the various considerations and provide an economic answer to the departure of a working shareholder because of death or incapacity. We regularly work with and can recommend insurance brokers who specialise in buy sell insurance.

Smith and Partners is highly experienced in drawing up the buy sell agreements that evidence the arrangements between the shareholders in respect of key person insurance and buy sell insurance.

Because buy sell agreements and buy sell insurance is a highly specialised field, it is important that businesses employ specialist professionals to advise them.

If you would like to discuss any matters relating to buy sell agreements or any other business law related matter; please contact business law specialist, Peter Smith on 09 837 6882 or at peter.smith@smithpartners.co.nz