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Business Succession Planning:

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Need for Succession Plan

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Simple Succession Plan:

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Complete Succession Plan:

Complete Succession Plan


Financial Needs

Insurance Funding

Retirement Funding


One Page Strategy:

One Page Strategy

Asset Needs

Liability Needs

Personal Needs

Who Pays the Premiums?

Valuing the Business

Simplifying the Valuation Issue

Equity vs. Loan Capital


One Policy Strategy:

One Policy Strategy


Dual Role of Personal Cover

Dual Role of Debt Red'n Cover

Security & Tax-Effectiveness

Cost Savings

Pre-Agreed Purchase Price

Apportionment of Premiums

Methods of Aggregation


Multiple Policy Approach:

Multiple Policy Approach

Super Fund Ownership

Tax Disadvantages

Cost Disadvantages

Other Disadvantages

Geared Premium Funding

Super Buy/Sell


One Page, Two Policy Strategy:

One Page, Two Policy Strategy


Other Issues:

Tax Deductibility

Inadequate Insurance Proceeds

Vendor Finance

Changing Needs

Future Growth of Equity

Trauma Buy/Sell Strategy


Sole Proprietors and Families:

Sole Proprietors and Families


Family Ownership

Sale Strategies

Third Party Buy/Sell Strategies

Estate Equalisation Strategies

Family Buy/Sell Strategies

Second Generation Strategies

Debt Reduction Strategies



The Complete Succession Plan

Issue 4: Retirement Funding (Voluntary Events)


This section focuses on how the financial needs identified in your Succession Plan can be addressed in the case of Retirement.


Your Retirement Strategy

Many of the issues involved in the design of an Insurance Strategy also arise in the case of a Retirement Strategy.

However, funding mechanisms other than Insurance are required (e.g. a Bank Loan, Instalments or Vendor Finance).


Options to Purchase ("Call Options")

The standard provisions in a Shareholders Agreement or Partnership Agreement usually include:

  • An Option to Purchase the Outgoing Proprietor’s Equity exercisable by the Purchasers only (a “Call Option”); and

  • A requirement that the Purchase Price be determined by a valuation process.

This gives certainty to the Purchasers, but not to the Vendor.

The Vendor (usually the Deceased Life Insured's Estate) will not know whether a sale will take place or what the Purchase Price will be, unless and until the Purchasers exercise their Call Option.

Usually, the Purchasers will not exercise their Option unless:

  • they are prepared to pay the required Purchase Price; and

  • they can fund the Purchase Price (either personally or by way of bank loan).

The second issue effectively makes the exercise of the Option conditional upon the Purchasers having a funding mechanism in place.


What if the Purchasers Don't Exercise the Call Option?

It is difficult for the Purchasers to exercise their Option, until they have determined the Purchase Price and assessed the feasibility of borrowing and paying this amount.

If they don't want to pay the agreed Price or can't afford to borrow or fund it, they would let their Option to Purchase (or Call Option) lapse or fall over.

The parties would then have to haggle over an alternative arrangement.

A Call Option gives the Purchasers certainty (if they want it), in the sense that it allows the Purchasers to fix or "cap" the Price they must pay to the Vendors.

However, it doesn't give the Vendors any certainty, until the Purchasers decide to exercise their Option.

In a sense, a Call Option creates a "Ceiling Price" for the Purchasers (i.e., a maximum Price thay can be asked to pay), but it doesn't create a "Floor Price" for the Vendors (i.e., a minimum Price they will receive).


Put Options

In order to give the Vendors certainty, the parties need a "Put Option".

A Put Option allows the Vendors to require the Purchasers to purchase the Equity for a Pre-agreed Price and on pre-agreed payment terms.

In effect, a "Put Option" is the reverse of a "Call Option".

Clover Law is reluctant to document a Put Option, unless there is a pre-agreed Funding Mechanism in place.

If a Purchaser commits to buy the Equity regardless of whether there is a Funding Mechanism in place, then effectively they are taking on a contractual obligation to pay the Purchase Price, regardless of whether they can ultimately obtain or borrow sufficient funds.

If they cannot obtain or borrow the funds, then they could be sued for breach of contract.


"Put and 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.

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 use of a combination of Put and Call Options is common in the context of Insured Events, in which case the Insurance Proceeds will provide the Funding Mechanism.

However, the same concept can be extended to Retirement, provided there is an acceptable Funding Mechanism for the Purchase Price.

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

  • Bank Loan; and/or

  • Instalments or Vendor Finance.


Pre-Agreement of the Purchase Price

When designing a Retirement Strategy, it is helpful to estimate or pre-agree the Purchase Price of the Retiree’s Equity.

This makes it easier to formulate funding strategies for the Pre-agreed Purchase Price now (when there is less emotion involved).

For example, if the value of the Equity might be $400,000 at the time of Retirement, the Proprietors can examine the cash-flow implications of:

  • a future Bank Loan; or

  • Vendor Finance.


Bank Loan or Finance

One option is to fund the whole or a part of the Purchase Price with a loan from a Bank.

However, the parties should not lightly assume that Bank Finance would be available at the time of the Un-funded Event.

For example, Bank Finance might not be practical if the Bank was likely to question the amount of the Pre-agreed Purchase Price or the ability of the Purchasers to service the Loan at the time of the Un-funded Event.

If this is possible, then the parties should consider Vendor Finance.

Bank Loan Funds Upfront Instalment

Clover Law often drafts Vendor Finance Provisions that require an upfront Instalment to be paid to the Vendor.

It would normally be expected that the Purchasers could fund this Instalment out of their existing resources or by way of Bank Loan.

In these circumstances, it would be necessary to disclose the Vendor Finance arrangements to the Bank in order to obtain approval of the Bank Loan.


Vendor Finance Provisions

Vendor Finance is designed to allow the Purchase Price to be paid over time.

The aim of Vendor Finance Provisions is to determine a timeframe that is:

  • short enough from the Vendor's point of view; and

  • sufficiently long from the Purchasers' point of view to enable them to fund the Purchase Price out of the cash flow of the Business.

If the Pre-agreed Sale Price is $400,000, then the parties need to determine whether the Price will be funded by:

  • a combination of an upfront payment and instalments; or

  • just instalments.

Upfront Payment and Instalments

The Vendor Finance Provisions could provide that the Purchase Price of $400,000 will be paid in:

  • one upfront payment of $200,000 (funded by a Bank Loan); and

  • four annual instalments of $50,000 per annum (plus interest).

Once these arrangements are formulated (at least tentatively), the Purchasers can examine the commercial and cash flow implications of taking out significant Loans or Liabilities shortly before their own Retirement (see below).

Where part of the Price is funded by a Bank Loan, the Purchasers would need to fund both:

  • the principal and interest payments owing to the Bank; and

  • the instalments and interest owing to the Vendors.


The Vendor Finance Provisions could provide that the Purchase Price of $400,000 will be paid in:

  • four annual instalments of $100,000 per annum (plus interest); or

  • eight annual instalments of $50,000 per annum (plus interest).

How Many Instalments?

The number and amount of the instalments should take into account both:

  • the need of the Vendors; and

  • the cash flow of the Purchasers.

The decision will usually be a balancing act between the interests of the different parties.

However, it is a lot easier to resolve these issues when they are abstract than when someone is actually ready to retire.

At the time of retirement:

  • one party is wearing a Vendor's hat and wants to reduce the timeframe for payment; and

  • the others are wearing a Purchaser's hat and want to increase the timeframe fro payment.


Your Purchasers' Own Retirement Strategy

It might not be wise for the Continuing Proprietors or Purchasers to assume these Liabilities to a Bank or the Vendor, unless they have considered the implications for their own Retirement Strategy (including the identity of the Purchaser for their own Equity).

Ability to Repay Bank Loan and Vendor Finance Before Own Retirement

After the Retirement of the first Proprietor, the Purchasers will presumably:

  • own 100% of the Equity in the Business; and

  • reduce the Bank Loan and Principal owing under the Vendor Finance arrangements over time.

However, if there are any outstanding Liabilities at the time fo their own Retirement, the Purchasers will need to repay them out of the Sale Proceeds of their own Equity when they retire.

Therefore, it is desirable that the Purchasers be able to identify a likely Purchaser (another Proprietor or, in the absence of a Proprietor, potentially an Employee or a Third Party) who will be able to pay the required Purchase Price at the time.

This issue is particularly relevant to Businesses where there are only two Proprietors or the Proprietors are of similar ages (and wish to retire at similar times).

Selling the Whole of the Business to a Third Party

If the Continuing Proprietors can’t identify a likely Purchaser for their Equity before or at the time of their own Retirement, there is a risk that the Continuing Proprietors might not be able to sell their own Equity and discharge the Liabilities.

This might make a Vendor Finance strategy impractical.

If so, the desire of one Proprietor to retire might force all of the current Proprietors to consider the feasibility of selling the whole of the Business to a Third Party.

This might involve bringing forward a potential sale to the time of the first Proprietor’s Retirement.

This would mean that the Continuing Proprietors would not have to fund the Purchase Price.

The Purchase Price would be funded by the Third Party Purchasers.

This would allow the market to determine the value of the Business.

All of the Proprietors would share in the market value proportionately to their Equity.

Under this arrangement, the Continuing Proprietors would avoid the risk that they might assume a large Liability, but not be able to repay it at the time of their own Retirement.

Whether the Business is sold to the Continuing Proprietors or a Third Party , the proposed Succession Plan can be pre-agreed and documented now.


The Valuation Process

A Business can "switch off" the pre-agreement provision in the standard Agreement, if it would prefer a valuation process at the time of a Retirement.

If the Purchase Price is not pre-agreed, care needs to be taken in the design of a Vendor Finance strategy, because the ultimate Purchase Price might be higher than the amount used for the purposes of any cash-flow analysis.


Fact Finder

Please click the following link to see the Un-Funded Purchase Price Item of the Complete Succession Fact Finder that has been completed for a Retirement Strategy:


The Other Three Issues:

Issue 1: Strategy (The Relationship Between Business and Personal Needs)

Click here.

Issue 2: Financial Needs ("The Three Needs")

Click here.

Issue 3: Insurance Funding (The “One Page, One Policy Strategy”)

Click here.

Copyright: Clover Law Pty Ltd



Adviser Tip

A Complete Succession Plan is not just about Death, it's not just about Insurance and it's not just about selling your Equity.

See more Adviser Tips







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