Question

My spouse is a 50% shareholder in a business that generates a consistent profit of R6 million a year. I am concerned about what would happen should he pass away.

What would happen to the income that we get from the business and would there be any estate duty implications?

Answer

Many families live comfortably because of a business, but very few have properly tested what would happen if the person actively involved in that business died.

A business may make R6 million profit a year, but that does not automatically mean that your family is entitled to keep receiving that income if your spouse dies. What you receive will depend on

• the legal structure of the business
• the partnership or shareholders’ agreement
• the buy-and-sell agreement
• the will

 and whether there is enough liquidity to turn his business interest into cash.

In other words, the question is not only, “What is the business worth?” The more important question is, “How does that value get converted into income for the surviving spouse?”

That is where many plans fall apart.

The remaining directors may not want to run the business with the deceased director’s spouse and business may not have the money to buy out the deceased director’s share.   This is why every business owner should have three documents that talk to each other

• a will
• a shareholders’ agreement
• a buy-and-sell agreement.

The buy-and-sell agreement is often the missing piece. A properly structured agreement says, in effect: if one director dies, the surviving directors must buy the deceased director’s interest, and the deceased director’s estate must sell it.

A buy and sell agreement is usually funded by life cover. The surviving directors receive the insurance proceeds and use that money to buy the deceased director’s share from the estate. This gives the surviving spouse cash rather than an illiquid business interest. It also allows the remaining directors to continue running the business without the deceased director’s family becoming unwilling or unsuitable co-owners.

Value of the business

Many business owners underestimate the value of their business . A common way to value a business is to apply a multiple to maintainable annual profit. For smaller private businesses, this multiple can vary widely, but a rough range is 3 to 5 times maintainable profit. 

On that basis, a business generating consistent profit of R6 million a year could have an indicative value of somewhere between R18 million and R30 million.  If your husband owns 50% of the business, his shares may be worth between R9 million and R15 million

This can create estate duty, executor’s fee and liquidity problems.

So what should you do?

Establish what your spouse’s business interest is worth. This should not be a thumb-suck. Get it done professionally.  A valuation should look at maintainable earnings, the business structure, debt, reliance on key individuals, recurring revenue, client concentration, and whether the profit would continue if your husband were no longer there.

Next, check the legal agreements. Does a partnership or shareholders’ agreement exist? Does it say what happens on death? Is there a forced sale? Who buys the interest? How is the value calculated? Is the formula still realistic? Does the agreement match the will?

Then check the funding. If the surviving directors must buy your spouse’s share, where will the money come from? If the answer is “from the business”, be careful. Taking a large amount of cash out of the business at exactly the moment it has lost a key person may damage the business and reduce the value of what your family receives.

My practical advice is this: do not wait for a crisis. Ask your spouse for a family financial continuity meeting. This is not about mistrust. It is about protecting you, the business partners, the employees and the business itself. The meeting should involve your financial planner, accountant and attorney. The output should be a simple answer to four questions:

1. What is the business worth?
2. What income would the family need?
3. Who buys the business interest on death?
4. Where does the cash come from?

A profitable business can be a wonderful family asset. But an illiquid business interest trapped in a deceased estate can become a nightmare. The goal is to turn business value into usable family capital, without damaging the business or creating unnecessary estate duty and tax problems.

That does not happen by accident. It happens by planning.