“Is your business prepared for the death of a partner?”, Published in The Star, On 20 May 2023.
In today’s fast-paced business world, entrepreneurs are often focused on driving growth and expanding their operations. While this is important for the success of a business, it’s crucial not to overlook critical long-term planning that can protect the business in unexpected situations.
As a financial advisor, I have noticed that one area that many business owners tend to overlook is planning for the possibility of the sudden death of a business partner. In this age of uncertainty, having a solid plan in place can be the difference between business continuity and failure.
The topic of death can be uncomfortable for many business partners. After all, it is difficult to imagine such circumstances when all partners are alive and healthy. However, it’s crucial to have these conversations and plan for the possibility of an unexpected death to protect the business and ensure continuity.
It is critical for Sdn Bhd companies to have a business continuity plan in place, as the unexpected death of a shareholder or director can have a significant impact on the company’s operations. This is because the shares of the deceased shareholder will pass on to their beneficiaries, who may not have the desire to continue holding onto the shares and participating in the business.
It is imperative therefore that business owners realize that plans for sustaining their business go hand in hand with their estate planning for their own families in the eventuality of their death.
Let’s take the example of Jeff and Kelvin, who started their business venture together. Jeff sees to the business development while Kelvin oversees the factory operations of the business. Both hold 50-50 stake in their company and withdraw just enough salary that is needed for themselves and their family. The rest of the profits are reinvested into growing and expanding the business, which means that nearly 70% of their net worth is tied to the business. Although the company is still at the growth stage, both have estimated their company valuation at 24 million, taking into consideration future growth potential.
Tragically, Kelvin passed away suddenly following an accident. In his will, he left his 50% of the company’s shares to his wife and children. Recognizing her lack of business acumen and the significant time commitment required to maintain the business’s success, Kelvin’s wife decided that it was much more beneficial to both parties to sell her late husband’s share of the business to Jeff.
While Jeff was more than enthusiastic on this approach, the two parties were unable to come to an agreement on the share’s value. On one hand, Kelvin and Jeff did value the company at 24 million, but on the other hand, Jeff was struggling to find a way to pay for these shares. Meanwhile, Kelvin’s wife had to consider supporting her family’s expenses and her children’s education.
In the end, because of the pressing needs of her family, and the inability on Jeff’s part to gain adequate funds, they had to settle at a significantly lower price for the shares than the company’s actual value. As a result, much of Kelvin’s hard-earned wealth that was tied up in the company did not get passed down to his family when he was gone.
In hindsight, what could Kelvin and Jeff have done differently to ensure that Kelvin’s hard work to build his empire and wealth would not go to waste in the event of his untimely passing? In this article, I will outline a few options available to business owners facing similar situation.
Let’s start with what happens to the shares once a business owner or shareholder passes away. In a Sdn Bhd corporation, the death of a shareholder does not dissolve the company. Instead, the heirs of the shareholders can opt to do one of five things:
- Wind up the business and distribute the balance of the company’s worth
- Sell off their shares to a new shareholder, who will continue to operate the business with the existing shareholders
- Continue running the business with the current shareholders
- Buy over the surviving shareholders interest and own the business entirely
- Sell off their shares to the surviving shareholders
The first four alternatives above share similar challenges due to the nature of the shares falling into new hands who may not be experienced or interested in continuing the business. Therefore, for the purpose of this article, we will be exploring the 5th approach, which is the selling of shares to the surviving shareholder, as in the case of Kelvin’s wife and Jeff.
It is not uncommon for business owners to have an informal agreement among themselves concerning their business interests in the event of unforeseen circumstances. This is particularly true for partners who have worked together for an extended period and share a strong bond and confidence in each other. They may have come to a verbal agreement to buy over each other’s shares or to take care of the deceased partner’s family in the event of a death or disability.
But as we all know, verbal agreements are based on trust and may not always be upheld. Situations can change as time passes, and partners may change their minds due to further financial burdens, relationship complications, and a barrage of other personal reasons. While verbal agreements are easy to discuss, there is no way to guarantee that they will be executed as agreed.
To best prepare for situations like the ones described above, partners should have a Buy-Sell Agreement in place, along with proper funding arrangements, when the need arises.
What is a Buy-Sell Agreement?
A Buy-Sell Agreement is a legally binding contract that sets out the terms and conditions of how a shareholder’s shares will be obtained by the surviving shareholder or owners of a firm in case of their death or departure. This contract can be drawn up by a lawyer who is knowledgeable in the field, and can include details such as the rights and obligations of the shareholders in disposing the shares of any deceased or disabled shareholders.
In the case of corporate shareholding companies like Sdn Bhd companies, there are a few options of Buy-Sell Agreements that can be drawn up. Let’s run through each of the options:
- Buy-Sell Agreement without Proper Source of Funding – typically, this involves business owners signing an agreement that legally-binds surviving business partners to buying over the shares of the deceased. It also typically legally binds the heirs of the deceased to selling their shares to surviving business partners.
However, when plans like these are signed without setting up a source of funding, the execution of it can be messy. While the surviving partners are legally required to buy the deceased’s shares, they may lack the financial power to do so, thus causing further complications.
- Buy-Sell Agreement with a Source of Funding – In a buy-sell agreement that involves a funding source, business owners sign a Buy Sell Agreement, as well as take out an insurance policy on one another for the required share amount. That way, if one business partner dies, the other will receive the insurance proceeds and will have the financial power to purchase the deceased’s shares.
However, there is a potential issue that needs to be addressed. In some cases, the surviving partner may end up using the money for other purposes, thus undermining the whole agreement and creating further complications.
- Buy-Sell Agreement with Trustee – Thus the best way forward with the least loopholes is usually the buy-sell agreement with trustee, where the business owners appoint an independent trustee who will oversee the process. When one partner passes, the trustee will receive the insurance proceedings. The trustee will then transfer the amount to the heirs of the deceased shareholders upon the transfer of the equity interest to the surviving business owners. This method ensures that the money is not misused by the surviving partner and guarantees the execution of the agreement without any complications.
When it comes to estate planning, many business owners tend to think they have their families taken care of, by bequeathing their company shares to them. However, they may not fully understand the complexity of such a situation should it happen, and how vastly things can change for their family and their business. To avoid such scenarios from taking place, it is best to take the necessary pre-emptive steps for peace of mind for both your loved ones and your business.
Yap Ming Hui is a licensed financial planner. The views expressed here are the author’s. Any reliance you place on the information shared is therefore strictly at your own risk.
The article is featured in The Star Online, at the following link: Is your business prepared for the death of a partner? | The Star