Anyone who owns a business will sometimes think about what might happen to the business if they were to die or because they can’t work due to medical or physical ill health.

These issues are particularly important when a business has more than one owner.

An important point to note is that I’m not only talking about the death of a business owner or key employee.

Ideally, we will consider this issue from the point of view of a person’s inability to work for an extended period of time including permanent disability, temporary disability and medical traumas and similar issues.

By medical traumas, I mean all the normal seemingly life threatening problems that can arise, such as brain tumours, cancer in major organs, major organ failure and so on.

Permanent disability means someone has made an assessment that you will be unable ever to work again, because of mental or physical ill health. Temporary disability is like permanent disability but is of a temporary nature.

When key people can’t work, the affairs of the business can go down very quickly, which means something must be done to protect the business if any of these situations were to occur.

Reluctant or incapable new co-owners

When a business owner dies, often their share of the business forms part of their deceased estate. If that share of the business is bequeathed to their close relatives, then problems can arise for the surviving business owners.

They may find their former business colleagues’ relatives have neither the skills nor the interest in working in the business and, in some cases, may even make the surviving business owners life a living nightmare by thinking they have business acumen.

In most cases, it is best that ownership of the business changes and the surviving relatives sell their share of the business. The trick for the other business owners is to make sure they’re the purchasers.

Dying intestate or estate disputes

An added complexity is how ownership of a business change can be delayed because a co-owner doesn’t have a valid Will or a Will that is contested, which takes several years to sort out.

How would you purchase your colleagues share of the business?

A key issue is how would a deceased or incapacitated business owner’s share of the business be acquired?

Most people don’t have the independent resources to acquire a portion of their business if they were required to do so relatively quickly.

Some will be able to call on parents or others to fund their portion of the purchase price.

Most, however, will have to rely on various forms of life insurance.

Funding the life insurance premiums

A key issue will be how to fund the appropriate insurance.

There are three different types of occupational insurance: any occupation where you are deemed unable to perform any future work; similar occupation where you won’t be able to perform work similar to your current occupation and, finally, your own occupation, which means you can’t perform your own job.

How will the insurance premiums be paid? Some people opt to use superannuation because they might get a tax concession on the insurance premiums and the proceeds. If paid to dependants of the deceased, the insurance might be paid tax-free.

What, however, will you do if one co-owner can’t obtain insurance because they suffer from some medical condition? Medical problems often emerge as we get older – as many of us who are middle aged can attest.

Several people have wanted to use their self managed super funds (SMSFs) in business succession planning. I have more to say about this below.

Agreements are often complex but necessary

It is nearly always essential to have a formal written agreement as to how and when the ownership of a business might change hands.

Often these documents are called buy/sell agreements.

The agreement will cover how the market values the business; what insurances are held; who is responsible for paying the premiums; what happens if the premiums aren’t paid and insurance lapses.

The agreement should also cover what happens when a claim is received; how the share of a business is formally completed; and most importantly, how all the various parties are bound to abide by the agreement.

In my view, it is essential to get these agreements professionally drafted. There are many tax traps that can cause a great deal of problems for the unwary and those who lack fine technical detail of the tax rules.

For example, last year, the Australian Taxation Office (ATO) issued guidance about using an SMSF to effect a buy/sell agreement. The parties involved demanded that an SMSF would be used to purchase insurance and that any insurance claim proceeds would be paid to the insured spouse, who would then transfer the ownership of the business to the survivors.

On the face of it, this looks a sensible arrangement. However, the ATO took the view that this agreement demanding the use of the SMSF failed a super law known as the “sole purpose test”.

It would seem that in this case the arrangement was poorly structured.

So if you want to use your SMSF, or any super fund, for your buy/sell agreement, it is probably a good idea to get some very good advice.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.