The Problems with Current Business Exit Agreements

Evanna Phoon wrote the below article and she is a Senior Franchisee of Rockwills. She can be contacted at info@malaysiawills.com

In the previous section, we have discussed the two examples with some existing business exit planning, firstly, to save cost, some business owners execute it’s business exit plan without the appointment of a trustee and power of attorney. Secondly, the distribution of sales proceeds were not well thought off. Resulting in more trouble and hardship to the beneficiaries.

In this issue, we’ll explore two more examples on business exit plans or business succession plans executed by business owners that are done wrongly & defective in some ways.

 

Problems with some existing business exit planning or business continuation plans

a)    Using keyman insurance to fund the purchase of the shares

Many business exit plans created using the insurance proceeds from keyman insurance policies. In summary, a keyman insurance policy is a policy that is insures the life of key personnel of the company. It is paid for by the company and therefore, this keyman insurance policy is owned by the company, rather than by the key personnel. The idea behind keyman policy is to compensate the contracted amount to the company for the financial losses that would arise from the death or total permanent disability of the key personnel mentioned on the insurance policy. This insurance policy facilitates the continuity of the business.

When a keyman insurnace policy is used for business exit plan, it will be caught under section 67 of the Companies Act 1965. It prevents a private limited company from purchasing its own shares or to provide any form of financial assistance to the shareholder or any third party directly or indirectly to purchase the company shares of another shareholder. As such, when the proceeds are used to purchase the shares of the deceased shareholder, whether it is disguised as gratuity to the family or not, on the understanding that such payment is in exchange of the shares of the deceased shareholder, it will be caught under section 67 of the Act.

The Directors of the company will be held liable when the company is found to infringe section 67. The penalty faced will be a fine of RM100,000 or 5 years imprisonment or both.

a)    Payment of insurance premium by the company

As mentioned in the earlier articles, the business owners are to pay for the premium using their personal funds. If the business owners are Directors, he will be able to use part of the Director’s fee received to make such payment. If he is a shareholder, then any dividends received can also be used to make such payment. The company is not allowed to use its funds to pay for the premiums (whether or not it is categorised as deductible expenses or not) and if it does, it will contravene section 67. Again, if caught, the penalty faced by the company directors will be a fine of RM100,000 or 5 years imprisonment or both.

In summary, let’s take a look back on the advantages of creating a proper business exit planning

a)    The Business Exit plan and business owners guarantee the sale of the business interest at a fair value. It sale price is stated in the buy-sell agreement. At the same time it avoids the unqualified heirs from being part of the business or selling of the deceased’s shares to outsiders.

b)    When the Business Exit plan is put in place, it avoids any unnecessary argument or negotiation over the purchase price between the heirs and the surviving business owners. This is important even though the Memorandum of Association and Articles of Association (for private limited companies) provide pre-emptive rights to shareholders regarding the disposal of the shares by way of a sale. However, the pre-emptive rights do not mention to pre-agreed price that is fair to the parties. The heirs and surviving business owners would still need to agree on a price to sell the shares. The heirs and surviving business owners may disagree for on the proposed price and the deadlock can last a very long time. In the meantime, the surviving business owners would have to work with the heirs.

With a Business Exit Plan, this is avoided as the parties can longer have the right to discuss on the pricing. It has been agreed and stated in the agreement that binds the business owner, his heirs and estate of the business owner.

c)    With a power of attorney, it provides for a smooth transfer of outgoing business owner’s interest to the purchaser when the specified events occur. There is no need to wait for the personal representative to act or worse still when the outgoing business owner is disabled or in coma, to wait for his recovery to sign Form 32A.

d)    As the business or the company is a not a public listed company, there is no outside market to sell to. The existing business owners would be the natural purchasers. Thus, with a Business Exit plan, it ensures that non-liquid stock/interest is converted to liquid income, providing a fund for outgoing business owner or for his loved ones to use during their time of need.

e)    The Trustee ensures that the outgoing business owner’s interest are properly transferred to the surviving business owners and the sale proceeds are distributed proper without involving the surviving business owners and family members of the outgoing business owner. By implementing a trust, the business owner can ensure that the sale proceeds are not misspent by his beneficiaries.

f)     The business carries on like normal and the suppliers/creditors can be assured of the existence of the business. The key employees will be willing to remain within the business due to the smooth transfer of ownership to the remaining business owners.

In reality, when we discussed the exit planning with business owners, it is very common that they will try to find a way to “save cost”. However, as a professional, our duty is always to highlight the issue and suggest suitable options for business owners after evaluating their situation.

We’ve been discussing extensively for the past 5 issues in Malaysia SME articles, talking on exit planning when businesses consist of partnership among non-direct family member, which includes friends, siblings or relatives

Starting from next issue, our topics will switch to Family Owned Businesses and how to plan for the continuation of Family Business. Stay Tuned …

 

About the Author:

MalaysiaWills CEO, Evanna Phoon.

Evanna Phoon is CEO & Founder of www.MalaysiaWills.com, Malaysia’s first 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 info@malaysiawills.com.

 

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Monday, March 19th, 2012 article

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