COVID-19: Business Succession Planning
April 27, 2020 / Wills & Estates
The COVID-19 pandemic has had a devastating
impact on many of us. One thing that it has undoubtedly highlighted is that
none of us are immortal and it has forced many business owners to think
critically about whether they have suitable plans in place in the event that
they pass away or become incapacitated.
While succession planning has always been
important, many people tend to overlook it as being something that they’ll ‘get
around to later’. However, as many businesses are now finding out, that can
have catastrophic consequences if tragedy strikes when unprepared. We have witnessed
significant disputes between families and owners that have resulted in
substantial financial losses, the distressing breakdown of previously strong relationships
and ultimately the closure of successful businesses. In our experience, the time
and monetary outlay required to plan is almost always the cheapest and most
prudent path to take.
Given the current uncertainty we now face, businesses
who have yet to do so should strongly consider putting a business succession
plan in place now. Those who already have a plan in place should review it and
ensure it is up-to-date, functional and achieves the desired outcomes.
The succession planning process
Business succession plans should be tailored
to suit each business. Owners need to consider and identify the individual needs
of the business to determine the desired outcomes before putting in place the
documentation to achieve those outcomes.
A comprehensive business succession plan
should have procedures in place for not only the death of any of the directors
or owners but also their incapacity, whether temporary or permanent. While
mechanisms for passing control and ownership of assets are important, the plan
should but also consider possible taxation implications and other risks, for
example potential inheritance claims, that could potentially defeat the desired
outcome being achieved.
Decision-making powers
While the passing of ownership of business
assets and entities upon death is often at the forefront of people’s minds, one
of the most important issues that should be considered is how the business
would continue to make decisions in the event of the death or incapacity of one
of its owners?
For example, if the business is carried on by
a sole trader, have appropriate documents been entered into to confer on one or
more persons the power to make decisions on behalf of the owner in the event of
death or incapacity? Is that power conferred on a person or persons who have
the appropriate skills to make decisions in respect of the business?
If the business is carried on by a company
(either in its own right or as trustee of a trust), are there other directors
who can continue to make decisions in the event of the death or incapacity of
one of them? Does the constitution of the company contain a suitable mechanism
to allow for the appointment of a replacement director? Is the director also a
shareholder? Who has the power to exercise the rights of the shareholder in the
event of incapacity or death?
What documents do I need?
While circumstances will be different
depending on the objectives of each business owner, there are several tools
that are commonly used to achieve the desired outcomes in the event of death or
incapacity. This list and the examples given are not exhaustive, but some
examples of the tools available include:
Your Will
- A Will is often the first document considered for the purposes of succession planning. Ensuring the provisions of a Will have been updated to accurately reflect and accommodate the wishes of the testator with respect to their assets and interests in other entities, and to ensure that its terms are consistent with the terms of any other succession planning documents, is critical. This includes ensuring that appropriate persons are appointed as executor, given that this person or persons will have control over the estate assets during administration of the estate. Inappropriate dealings with the assets by the executor could not only defeat the succession planning objectives, but may also trigger unintended tax consequences.
Where circumstances have changed since a Will has been drafted, existing Wills should be reviewed, and either a new Will or Codicil put in place to address this.
Enduring Power of Attorney
- Granting powers of attorney may be used to ensure that an appropriate person or persons have the right to exercise the powers of the individual, including rights attached to any shares in a company (whether conducting the business in its own right or as trustee of a trust), during any period of incapacity. Consideration should be given to the powers granted to the attorney and, in particular, whether the powers should be restricted at all to protect against an attorney potentially exercising the powers in a manner inconsistent with the overall planning objectives.
Consideration should also be given to the limitations of such powers, particularly where the business structure contains one or more companies, as an attorney cannot exercise the powers and duties of the grantor in his or her capacity as a director of a company.
Shareholders Agreement and Company Constitution
- Where assets are owned by a
company, a Shareholders Agreement or Company Constitution is a valuable tool to
customise the rules relevant to the conduct of the company to suit the specific
needs and objectives of the parties. These are useful both where the company
owns assets in its own right, and where it does so as trustee of a trust. Issues
that are commonly addressed in these agreements include:
- the
right to appoint and remove directors, including alternate directors;
- who
can make decisions and what percentage of votes are required to pass a
resolution;
- whether
any shareholder or director will have a casting vote or right of veto in
respect of any decisions;
- rules
around the issue of new shares and prohibitions against diluting the
shareholding of any shareholders;
- exit
strategies and rules and procedures that must be followed if any party wishes
to dispose of all or part of their interest or in the event of certain events such
as death, incapacity or retirement;
- policies
as to declaration and payment of dividends;
- rules
around borrowings to be undertaken by the company and/or contribution of
capital; and
- dispute
resolution procedures.
Option Agreements
- In some instances, call options can be used to secure the right of another party to acquire ownership interests in an entity in the event of certain events such as incapacity or death of an existing owner. These are most often used when unrelated individuals enter into a business together to protect against disputes arising between the continuing owners and the representatives of the deceased or incapacitated owner in relation to the buyout of that owner’s interest.
Call options can also be useful to secure a family member’s right to acquire a certain asset on the death of the existing owner if there are any concerns of an inheritance claim or other issues arising during the administration of the estate that may defeat the passing of that asset to the intended person.
While the grant of a call option is unlikely to trigger any tax implications, the exercise of the call option will, and therefore this needs to be taken into account as part of the broader succession plan.
Trust Deeds – Appointments and variations
- Where a business is run through a
discretionary trust, consideration needs to be had to both control of decision
making at the trustee level, as well as mechanisms to ensure appropriate
distribution of income or capital of the trust. Relevant issues here include:
- where
the trustee is a company, putting in place a shareholders agreement or other
document to regulate decision making of the trustee company and other relevant
issues;
- ensuring
that the role of appointor is passed to appropriate persons to protect against
an existing trustee being removed and a new trustee appointed who may not act
in the best interests of all beneficiaries; and
- distributor
provisions to ensure equitable distribution of income and capital between
beneficiaries.
Superannuation
- In some
instances, assets such as premises from which the business is conducted are
held in a self-managed superannuation fund. As the death of a member triggers a
cashing event in the fund, if this event is not properly planned for, the fund
may be forced to sell or otherwise dispose of the property in order to fund these
payments. A comprehensive business succession plan should therefore include a
strategy in relation to dealing with any business assets held in a self-managed
superannuation fund.
Restructuring
- Where current ownership
structures to do not adequately accommodate succession planning objectives, it
may be possible to utilise various tax concessions including the small business
CGT concessions, and the small business restructure roll-over to enable
ownership to be restructured with minimal tax implications.
Social distancing restrictions
The current social distancing restrictions in place do not mean that it is too late to do any of the succession planning that you need to do. We can put measures in place to overcome the social distancing restrictions through the use of technology. There are strict requirements of witnessing Wills to ensure validity in accordance with the Wills Act 1936 (SA) and we encourage our clients to discuss this with us so that we can provide options based around each client’s personal circumstances. It is not too late to put necessary documents in place, and if you need to get on top of your succession planning, we urge you to contact us to discuss your circumstances.
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This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied upon as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Should you wish to discuss any matter raised in this alert, or what it means for you, your business or your clients' businesses, please feel free to contact us.