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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

 

 

 

 

 

 

 

 

 

 

Put and Call Options

 

The Limitations of Call Options

A Call Option does not necessarily result in a Sale and Purchase of the Equity.

It needs the Purchasers to exercise their Call Option.

They will only exercise their Option, if they have a satisfactory Funding Mechanism.

However, it is possible to design a more binding Succession Plan (from the Vendor's point of view), if there is a:

  • Pre-agreed Purchase Price; and

  • Pre-agreed Funding Mechanism (such as Vendor Finance).

The pre-agreement of the Price and the Funding Mechanism means that:

  • there is no uncertainty about the amount of the Price; and

  • the Purchasers have a Funding Mechanism (other than borrowing from a Bank) that takes into account their ability to pay the Price out of the cash flow of the Business over time.

This strategy takes away the uncertainty with respect to funding that is a reason for many Call Options not being exercised.

 

Combination of Options

If this Strategy is acceptable to all of the parties, it is possible to structure a Succession Plan that consists of a combination of:

  • a Put Option that would be exercisable by the Vendor; and

  • a Call Option that would be exercisable by the Purchasers.

The exercise of an Option by either party would trigger a Sale for the Pre-agreed Sale Price on the pre-agreed Vendor Finance terms.

 

The Need for a Funding Mechanism

For the above reasons, if the parties want to create certainty for both the Vendor and the Purchasers, then they must effectively pre-agree a Funding Mechanism (e.g., Vendor Finance Provisions).

If a Funding Mechanism can be agreed in advance , then the Agreement can:

  • go beyond a Call Option; and

  • create Put and Call Options pursuant to which one party or other can force a Sale to occur in accordance with the Vendor Finance Provisions.

The Agreement can provide that the Purchase Price be paid by way of:

  • Bank Loan; and/or

  • Instalments or Vendor Finance.

 

Retirement

Click here to read about the use of Put and Call Options in the case of Retirement.

 

Inadequate Insurance Proceeds

Click here to read about the use of Put and Call Options where it is not possible to obtain all of the Buy/Sell Insurance that is required to fund the Purchase Price.

 

"Conditions Precedent"

The same effect as Put and Call Options can now be achieved by properly drafted "Conditions Precedent".

 

CGT Issues

Both alternatives require careful drafting to avoid CGT liabilities.

Click here to read about the potential CGT liabilities.

This drafting is often not in standard Shareholders Agreements and Partnership Agreements.

 

 

Copyright: Ian Gray Solicitor

 

 

Adviser Tip

"Conditions Precedent" and "Put and Call Options" are just methods of legal drafting that postpone the date of disposal of the Equity in the Business from the date of the Business Succession Agreement to after the date of occurrence of the Insured Event.

If correctly drafted, both methods are acceptable to the ATO.

See more Adviser Tips

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