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Advice for SME Owners - Planning for Untimely Death

Unless there is a lot of prior planning, the death of a business owner can result in the company being liquidated, sold to outside parties or surviving family members may have to become active in running the business themselves.  To plan for the future orderly disposition of a business, a buy-sell agreement can be entered into.  A buy-sell agreement may be between shareholders of a company, partners of a partnership or a key employee and a sole proprietor.  The buy-sell agreement will oblige the surviving business owners, key employee or the business itself to purchase the interest of the deceased owner.  This agreement will need to be drawn up by a legal professional and there are three different types of buy-sell agreements to consider:

  • Cross Purchase – this type of agreement involves the business owners (partners or shareholders) to enter into an agreement whereby the surviving owners are obliged to buy the interest of the deceased owner and the estate of the deceased is obligated to sell.
  • Entity – this type of agreement obliges the business itself to buy the interest of the deceased owner and the estate of the deceased is obligated to sell.  If the business is the corporation, this entity agreement is often referred to as a stock redemption agreement.
  • Wait and See – in cases where it’s difficult to decide whether to use a cross purchase agreement or an entity agreement, a “wait and see” can be used.  This type of buy-sell agreement provides a level of flexibility in that it’s not decided until the owner’s demise whether the surviving owners or the business purchases the interest of the deceased owner.

In the event of the business owner’s death, business partners, family members of the deceased or key employees may find themselves struggling to raise the finance necessary to complete the purchase of the business interest.  We’re going to take a look at some common sources of funding available in such an event.

  • Sinking Fund – the unexpected death of an owner may not allow the business the necessary time to accumulate the purchase price.
  • Personal Funds of Owners – most business owners do not keep large sums of liquid assets that would be necessary to purchase the interest of the deceased as most of their money would already be invested in their business.
  • Borrowed Fund – a bank may be unwilling to lend money to a business that has recently lost an owner in this way or it may be that the cost of the interest on the loan may be excessive.
  • Instalment Payments – the heirs of the deceased business owner may not receive the sum of money needed to settle death costs and there is no guarantee of future payments if the business should fail.
  • Life Insurance – this offers some advantages that the other options do not, such as:
    • Life insurance annual premiums are often a small fraction of the death benefit.
    • Death benefits are available when needed, regardless of when the owner dies.
    • Death benefits are usually income tax exempt.

Whatever you want for your business in the event of your untimely death, making sure that you seek the advice of a professional is essential.