Evanna Phoon wrote the below article and she is a Senior Franchisee of Rockwills. She can be contacted at firstname.lastname@example.org
In the previous article, we covered Item #1 & #2 of Diagram A. Basically, we described the method of valuing businesses and appropriate funding in various scenario where all partners are insurable, some partners are not insurable while some partners are in-active co-owners.
In this issue, let’s move on to explain more in detail on Item #3 of Diagram A.
There are 2 types of agreement,
Type #1: Buy-Sell Agreement
Type #2: Cross Option Agreement.
I intend to cover only the important content or points for the Buy-Sell Agreement. Let’s leave the detailed contents and manner of drafting to the lawyers, which is what you are paying them for. The agreement must be drafted by experienced corporate lawyers who are familiar with Business Value Protection.
Please be assured that whether it is a Buy-Sell Agreement or Cross Option Agreement, when executed by the parties, it is a legally binding contract ensuring the protection of the business value and its continuation by the remaining business owner(s).
1) Buy-Sell Agreement
When one agrees to a Buy-Sell Agreement, it is mandatory that upon occurrence of one of the trigger events such as death, total permanent disability, retirement and critical illness, the remaining business owner(s) as the purchaser MUST buy from the outgoing party who is the seller. In turn the seller MUST sell to the purchaser. There is no longer any room to negotiate about the pricing and whether to purchase or sell the business interest. When a party fails to fulfill the obligation stated in the agreement, it amounts to a breach where the defaulting party is liable to pay damages.
The important content or points of the agreement are:
a) Method of valuation? In every Buy-Sell Agreement, it must clearly state the VALUE of the business. There are 2 ways to establish an agreed valuation method,
Method #1 Formula Basis: if the business owners prefer a formula basis to determine of the business value, it should be approved by an experienced accountant. This is because it avoids the need to execute further supplemental agreement(s) when a review of the value if made. The method of valuation must be clearly stated to avoid confusion.
Method #2 Fixed Price: if the business owners agreed to use a fixed price , they must be prepared for a periodical review and to execute supplemental agreements and to pay for such supplemental if there’s a change in value
b) What are the trigger events agreed upon?
The most common triggering events we encounter are
- Total permanent disability
- Critical illness
However, there are some not so common triggering events, such as
- Loss of professional license,
Deadlock between business owners.
c) How is the purchase funded? If life insurance is used and it is assigned to the Trustee, it is to be stated in the agreement. In some cases, instead of an assignment of the insurance to the Trustee, the Trustee is appointed in the insurance nomination under Section 166 of the Insurance Act 1996. This is to prevent the 6% service tax being charged to the client. However, the nominees named in Section 166 and their entitlement must be exactly the same in the Trust Deed.
d) When is the completion date of the sale and purchase? – This depends on the trigger events agreed by the business owners, sometimes there will be different completion dates on the occurrence of different events. For example, the business owners can agree on 12 months upon occurrence of death but on 36 months when it comes to retirement. If life insurance is used as funding, there will be different time frames for the pay out by the insurance company as it depends on whether the type of disability. Sometimes, it can as long as 36 months. Whether the completion date is 1 month or 60 months, what is important is that all the business owners must agree on the time frame for the completion of the sale and purchase. They have to ask themselves whether they can pay up the moneys to complete the purchase.
e) What about the Trust Deed and Power of Attorney? As these two instruments are an integral part of Business Value Protection Plan, the business owners are to execute them at the same time with the Buy-Sell Agreement.
f) When should the parties review the value of the business? Usually the agreed period is 3 years. When the review period is agreed upon, with the necessary attendance quorum being achieved, and there is an increase in value, the business owners will be required to prepare the necessary funding. This could mean they may have to purchase additional insurance policies.
g) Dealing with shortfalls – the business owners have to agree on this important point as the life insurance proceeds may not amount to the full purchase price due to the appreciation of the value of business and where the parties are no longer eligible to be insured further. What needs to be decided is the installment period to pay up for the shortfall. For the purposes of convenience, when a trigger event occurs and upon the initial payment of the purchase price, the Trustee using the power of attorney shall transfer all the business interest of the outgoing party to the purchasers even though the full payment have yet to be received. The purchaser(s) shall owe a debt to the Trustee who represents the vendor and his beneficiaries.
h) What happens if the insurance policy proceeds exceed the value of the business interest to be purchased? Any excess shall be returned to the party who pays for the insurance premium of the seller. I doubt that the parties would agree to the seller receiving the excess.
About the Author:
Evanna Phoon is CEO & Founder of www.MalaysiaWills.com, Malaysia’s 1st online will writing service provider for Rockwills Corporation Sdn Bhd & As Salihin Trustee Bhd. Visit her website to download FREE ebooks & watch over 300+ videos on the topic of Will Writing for Personal & Business. She can be contacted via email@example.com.