“In this world, nothing is certain except death and taxes.” – Benjamin Franklin
Inevitably, a business will be presented with the jarring and uncomfortable task of replacing one of their key members due to death or disability. This certainty means that contingency plans are imperative.
Before we consider the plans one should have in place, let’s look at a few definitions:
Key-man-policy: a policy that is owned by the company, taken out on the life of an employee, with the proceeds being paid out to the company in the event of an employee’s death or disability.
Buy-and-sell insurance: ensures business continuity by enabling existing shareholders to purchase the deceased or disabled shareholder’s shares at fair value.
Now, consider the following example:
Luke, Leia, and Johan are the managing directors of a well-known company called “Star Consultants”, providing in-depth knowledge on business management to the wider population of South-Africa. Luke falls terminally ill and unfortunately passes away, leaving his remaining partners not only with the tragic loss of a friend and colleague but also the loss of immense knowledge and clients, due to Luke’s loyal client base being less inclined to deal with a new incumbent.
A “key-man-policy” pay-out has the potential to be the saviour of Star Consultants, who are faced with a substantial loss of income and the woefully illiquid estate of their deceased partner. The payment is made directly to Star Consultants, as the policy holder, who, depending on the circumstances, may utilise the funds to save the business from insolvency or give their business an unexpected financial boost.
A “buy-and-sell” policy, on the other hand, will be desirable where business owners have the majority of their wealth tied up in the business, allowing the surviving shareholders of Star Consultants to obtain the necessary capital to purchase Luke’s shares from his deceased estate at a fair value, without compromising their investment in the business. The certainty of death makes a “buy-and-sell” policy particularly important in professional businesses, such as a law firm or medical practice, where a shareholder requires a minimum qualification to hold the shares. It lifts the burden of the surviving shareholders to source large amounts of capital or face the sale of the shares from the deceased estate to an unknown third party. It is, therefore, an effective tool in ensuring shareholder protection, client retention, business continuity and business security.
The most important part of the buy-and-sell agreement, insurance policy excluded, is the written agreement between shareholders. This agreement would effectively set out how the proceeds of the policy should be paid out to the deceased’s family or to the disabled shareholder, and will create certainty amongst the shareholders. Not only should this agreement determine the valuation of the business, but it should also formalise an understanding between the shareholders to purchase the deceased shareholder’s share, and his or her intention to sell, in the event of death or disability.
Shareholder and business protection through insurance policies could be vital to the long term success of the business, and it is imperative that these protective measures are implemented from the outset. The appropriate structuring involves determining shareholding percentages, valuation methods, valuation intervals and the current value of the business, so as to ensure that the appropriate level of coverage for each shareholder is obtained. Once this is done, consideration should be given on the insurability of the shareholders and their willingness to enter into such an agreement.
“Key-man” and “buy-and-sell” policies can be implemented in a multitude of ways, which can be overwhelming for the average shareholder or business owner. A bespoke approach tailored to your particular circumstances by the professionals is the best way to ensure peace of mind in the long term.
Contact VST Attorneys today and allow the experts to draft you a bespoke shareholders agreement specific to your unique business, as well as provide guidance on the appropriate protection measures which should be implemented.
Written by: PW van Der Westhuizen (CA)
Edited by: AJ Truter (director)
