Question

During the holidays, I took a good look at my personal finances and realized that I have invested pretty much all my assets in a business that I own with a partner.  I have no retirement savings or other assets to speak of.

My concern is that should I die, how will my family get paid out for my share of the business as the company does not have sufficient cash reserves to pay out my share of the company.  I do not want them to be in a situation where they have to rely on the goodwill of my partner.

Answer

This is an important issue that anyone who is a shareholder in a small business needs to consider.  Should you or one of your fellow shareholders pass away, the deceased’s family will be entitled to their share of the business.

If the company does not have sufficient cash flow to do this, there are a couple of options open to you

• assets may have to be sold in order to pay out this amount.
• the deceased’s family could get involved in the company and your company going forward.
• the deceased’s family may sell their shareholding to someone who is not currently involved with the company.

Any of these actions could end up with unfavorable consequences for the company.

A solution is to set up a buy and sell structure. Here you and your partner agree that should either of you die, you would sell your interest in the business to the surviving partner. This will ensure that the business carries on as before and that you do not have any forced partnerships with someone you do not want in your company.

The surviving shareholder will need cash to fund this share purchase this is done through each director taking out life insurance on each other’s lives so that  when there is a death, there will be cash to buy the shares.

It is important that the policies that are used to fund these buy and sell arrangements be set up correctly.  There can, for example, be serious consequences should the wrong person pay the first premium on the insurance policy.  I would therefore advise you to speak to a financial planner who specializes in business assurance.

If you have a buy and sell agreement in place along with the necessary insurance policies, business disruptions will be minimized when a director dies and the business dynamic will be preserved. 

It is important that you value your business on a regular basis and ensure that you have the correct levels of insurance cover to reflect the current value of the business.