Succession Planning and Involuntary Exits
A common challenge for any business, big or small, is planning for changes in management and/or ownership as this often involves dealing with issues people wish to avoid for one reason or another. Whilst a planned exit has a variety of complications like timing, funding and obtaining the correct value, an involuntary exit (i.e. death) brings an additional set of challenges.
Often a significant challenge is ensuring the relevant estate receives appropriate value for the interest in the business. Depending on the business structure, this can be by way of a shareholder or partnership agreement. The protocols in these agreements should set out the methodology to determine value and obligations/expectations, however, the funding of such obligations/expectations can prove problematical.
Where an agreement provides for one party to buy out another, often a life insurance policy is taken out on the other party to assist the acquirer, as spare cash or borrowing capacity may not otherwise be available.
Where there are only two parties involved, this is an effective strategy as the life insurance proceeds fund the acquisition of interest (or part thereof). Where there are multiple parties or incoming and outgoing parties over an extended period of time such an approach is problematical, as the assignment of an interest in a life insurance policy can result in unintended tax issues (i.e. the proceeds may become taxable). Such issues arise when an interest in a policy is assigned for consideration, which the ATO may view as including a reduction of exposure to contingent liabilities.
When examining options for succession planning and the structuring of insurance policies, care must be exercised. A number of options exist to facilitate a smoother transition including insurance trusts, self insurance, cancelling and renewing policies as required and multiple lower level policies, however, they need to be considered in light of the relevant circumstances and practicalities.
Should you wish to discuss how any of the above or have any other matters may be applicable to you please contact your ESV engagement partner on 9283 1666.
Article by David Prichard