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Publications and Documents:
Adviser Tips:
Adviser Updates:
Individual Updates (Most Recent First): Adverse ATO Advice on Super Buy/Sell Cover Partnership and Trust Loan Accounts Effect of Debt Reduction Cover on Buy/Sell Cover Tax Treatment of Self-Ownership Agreements Vested and Indefeasible Interest Simplifying the Valuation Issue Simple or Complete Succession?
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Valuing the Business
In many cases, Business Proprietors have an inflated view of the value of their Equity in the Business. This impacts on the expectations of their Spouses and Beneficiaries if they die and can cause disputes with the Continuing Proprietors. Their expectations are usually driven by the need for the cash required to fund their living expenses, as well as any personal debt, alternative venture or investment strategy. Ultimately, this is a personal need. However, it affects the value they place on their Equity in the Business.
Two Sources of Income from the Business While the Life Insured is alive, the income from the Business effectively derives from two sources:
When the Life Insured has died or is no longer able to work, they are no longer able to generate income from their labour. However, theoretically at least, their capital might still be able to generate a profit (subject to any drop in the revenue or goodwill of the Business).
Valuation Methodology Because the Business funds two sources of income, it is understandable that people will try to value the Business on the basis of the capital value of both sources of income. However, in most cases, the valuation of the Business (including the goodwill) will not take into account the amount of the salary received by the Life Insured. Most valuations assume that the Business will pay market salaries for the labour supplied to the Business, before its capital value is calculated. They will assume that, if the work was done by someone else, that person (not the Proprietor) would receive a market salary for their labour. In most cases, the valuation will only take into account the recurring profit attributable to the capital investment in the Business (multiplied by an appropriate "cap rate" or capitalisation ratio to arrive at the capital value of the goodwill). As a result, the value of the Life Insured's Equity in the Business will normally compensate the Spouse or Beneficiary for the capital value of the profit from the Business. It will not necessarily compensate the Spouse or Beneficiary for the loss of the Life Insured's salary income. This need would normally be funded by superannuation, other investments or Personal Insurance Proceeds.
Complete Succession Plan Using the language of the Complete Succession Plan, this means that:
As a result, a Complete Succession Plan allows Proprietors to achieve the appropriate target amount of capital, as well as enabling them to divide it appropriately between Business and Personal Needs.
Simple Succession Plan In the absence of a Complete Succession Plan, the Spouse or Beneficiary might expect the valuation of the Business to compensate them for the loss of income. In other words, they will expect the Sale Price to take into account both:
These expectations and valuation issues can lead to significant disputes, a break-down in relationships, loss of customers, and the loss of capital value. These disputes can be minimised, if the parties have pre-agreed the Purchase Price of the Equity. Simplifying the Valuation IssueClick here to see how the One Policy Strategy simplifies issues with respect to the valuation of the Business and the determination of each Proprietor's Purchase Price. |
Adviser Tip The One Page Strategy is designed to help you simplify Succession Planning. It helps you understand your needs, it helps you quantify them, it helps you cost them, and it helps you prioritise them.
Please contact us to arrange a meeting or teleconference.
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