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Overview:

Business Succession Agreements

 

Types of Agreement:

Types of Agreement

Cross Ownership:

Cross Ownership

Self Ownership:

Self Ownership

Related Party Vendors

Deemed Dividends

Risks If No Agreement

Trust Ownership:

Trust Ownership

Tax Implications

"Business Family Will"

Changing Needs

Benefits

Choice of Trustee

Super Buy/Sell

 

Drafting Issues:

Put Options

Call Options

Put and Call Options

Conditions Precedent

Put and Call Options vs. Conditions Precedent

 

Other Issues:

Pre-Agreed Purchase Price

Inadequate Insurance Proceeds

Trauma Buy/Sell Strategy

Simultaneous Deaths

 

Debt Reduction Agreement:

Debt Reduction Agreement

 

 

 

Changing Your Succession Plan and Agreement

 

A Succession Plan is not just a static strategy.

It will change as the Business grows and its needs change.

The Complete Succession Risk Analysis Worksheet illustrates some typical changes in needs over a five-year period.

 

“Multiple Policy Approach”

If the cover was written on separate Policies (the traditional “Multiple Policy Approach”):

  • as the Debt reduces, the Debt Reduction Cover should be reduced, to avoid any risk that it might be treated as Key Person Revenue Cover (and taxed upon the payment of a claim);

  • as the Purchase Price increases, the Buy/Sell Cover should be increased; and

  • as Personal Needs reduce, the Personal Cover should be reduced.

These steps involve the administrative burden of dealings with the Insurance Company.

In addition, the increase might require new medical tests and underwriting requirements, which can take up valuable management time.

If the Life Insured cannot satisfy the Insurer’s requirements, an increase might not even be possible.

 

Single Policy Strategy

In contrast, the Single Policy Strategy is designed to place all of the cover under the one roof.

Once it is under the roof, you might find that you have the right total Sum Insured for the indefinite future.

All that needs to be changed is the "mix" or allocation of the cover.

It is not necessary to deal with the Insurance Company or do medical tests in the future, unless additional cover is required over and above the original total Sum Insured.

Thus, changes become a management issue, not an Insurance Company issue.

Rather than changing your Policies, the One Page, One Policy Strategy simply requires a change of the Schedules to your Business Insurance Trust Agreement.

Variation Agreement

Click here to read about the variation of the Agreement.

Cost Savings Fund the Cost of Changing Your Agreement

Regardless of the type of Agreement that documents your Succession Plan or Buy/Sell arrangements, there would be costs associated with any future variation of the Agreement.

However, the cost of variations of the Business Insurance Trust Agreement is designed to be funded as far as practicable within the scope of the savings in Policy Fees and Premiums.

In summary, the Business Insurance Trust structure is designed to save money, some of which is then used to fund the cost of keeping your Succession Plan up-to-date.

Click here to read about the Cost Savings that result from the use of the One Policy Strategy and Agreement.

 

Examples

Click here to see examples of the types of change that can occur.

 

When is a Variation Agreement Appropriate?

A Business Insurance Trust Agreement is designed to aggregate different needs onto one policy, where these needs would otherwise have been addressed by multiple policies at greater cost.

Instead of having to make multiple changes to multiple policies, the Business Insurance Trust Agreement allows the changes to be effected by a change to the Schedules to the Agreement.

Changes will occur in the same circumstances that it would have been necessary to review the separate policies.

However, it will not be necessary to deal with insurance company administration to make the changes.

Equally importantly, if it is not necessary to change the total sum insured, the Agreement protects the life insured from the adverse consequences of deterioration in their health.

A Variation of the Business Insurance Trust Agreement might be required to document any changes to the Succession Plan (including the insurance arrangements) required by:

Equity-Related Issues:

  • The resignation or retirement of a Proprietor;

  • The admission or introduction of a new Proprietor;

  • A rearrangement of the existing Equity in the Business held by the existing Proprietors (e.g., one Proprietor sells down some of their equity to the other Proprietors);

  • The restructure of the Business (e.g., the issue or redemption of shares or units);

  • The creation of a new Business Entity in which the Proprietors have a direct interest;

  • The acquisition of a property or other asset in the names of the Proprietors or their Related Parties;

  • A change (whether an increase or decrease) in the value and therefore the Pre-Agreed Purchase Price of any component of the Equity in the Business;

  • A consequential change in the capital gains tax payable with respect to the Purchase Price;

  • A consequential change in the transactional costs with respect to the sale and purchase of the Proprietor’s Equity;

Liability-Related Issues:

  • A material change (whether an increase or decrease) in the amount of any debt owing by the Business to third party creditors;

  • A refinancing of any debt owing by the Business to third party creditors that needs to be insured;

  • A material change (whether an increase or decrease) in the amount of any debt owing by the Business to the Life Insured (or any Related Parties) (or vice versa);

  • A change (whether an increase or decrease) in the value and therefore the Pre-Agreed Purchase Price of any component of the Equity in the Business as a result of the increase or decrease in the amount of any debt;

  • A change (whether an increase or decrease) in the cost or loss of a revenue nature that might be incurred as a result of the loss of a key person (e.g., the key person might be harder to replace because of the resignation of an associate who was being groomed to take over their specialty; alternatively, the key person might be easier to replace because of the appointment of an associate);

  • A change (whether an increase or decrease) in the cost or loss of a capital nature that might be incurred as a result of the loss of a key person(similar factors to a cost or loss of a revenue nature);

Personal Issues:

  • The consequential change in the need for personal insurance as a result of a change (whether an increase or decrease) in the Pre-Agreed Purchase Price that will be received by the Life Insured, their Estate or a Nominated Recipient;

  • A change (whether an increase or decrease) in personal debt;

  • A change in the financial dependence of a family member;

  • A change in the apportionment of the personal cover between the Life Insured and a Self-Managed Superannuation Fund as a result of the erosion of Reasonable Benefits Limits;

Insurability and Affordability Issues:

  • The need to re-apportion or re-prioritise the existing cover because of the inability to insure all needs to the required extent;

  • The need to re-apportion (or reduce) the existing cover because of the increasing premium cost; and

  • The need to determine the terms of payment of any shortfall in the Purchase Price (“Vendor Finance”), because of the inability to fund the whole of the Purchase Price with insurance.

 

When is a Variation Agreement Not Required?

The Business Insurance Trust Agreement recognizes that there are some circumstances or needs that will fluctuate during the term of an insurance policy.

In these situations, the standard Agreement identifies default allocations of the cover that operate automatically without the need for any formal Variation Agreement:

Total Sum Insured:

  • If the total sum insured increases because of a CPI increase, the increase is deemed to be personal cover and the default recipient is the Life Insured;

Debt Reduction Cover:

  • The amount of debt owing to both third party creditors (bank debt) and associated parties (loan accounts) may reduce or fluctuate over time.

  • If the Debt Reduction Cover is intended to repay a particular proportion of the specified debt (e.g., 25%), the Agreement specifies whether any insurance proceeds exceeding this amount (e.g., there might be insurance proceeds of $200,000, whereas 25% of the debt at the time of the claim might only amount to $100,000) will be paid to:

    • The Creditor;

    • The Business; or

    • The Life Insured.

  • If the Debt Reduction Cover exceeds the total amount of the debt at the time of the claim, the Agreement specifies whether the surplus will be paid to:

    • The Business; or

    • The Life Insured

In these situations, a Variation Agreement is not required merely because one of the anticipated changes has occurred, unless the parties wish to vary the default allocation of the cover.

 

 

Copyright: Ian Gray Solicitor

 

 

Adviser Tip

The One Policy Strategy is designed to place all of the cover under the one roof.

Once it is under the roof, you might find that you have the right total Sum Insured for the indefinite future.

All that needs to be changed is the "mix" or allocation of the cover.

See more Adviser Tips

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Current Marketing Schedule

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