Corporate Buy-out on Owner's Permanent Disability or Terminal Illness
Business Purchase - Business Sale - Equipment - Leasing - Financing - Amalgamation - Rollover - Expanding into Canada
Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
When a business owner's health worsens, in particular when they are diagnosed with a terminal illness or they become permanently disabled, divesting control and ownership of the business becomes an increasingly pressing matter. The complexity associated with buying or selling a business is only exacerbated the owner's permanent disability or terminal illness, given the significant additional legal, financial, and emotional considerations that must be attended to (and where the business owner is incapable of negotiating, such that their power of attorney must negotiate in their place, in conformity with their legal authority, while also maintaining the business, the process become that much more difficult).
In those situations, it advantageous if there is a pre-existing buy-sell agreement in place, which might form part of a corporation's unanimous shareholders agreement or a partnership's partnership agreement. The buy-sell arrangment is a legally binding contractual arrangement that outlines how an owner's share of the business will be handled in the event of disability (together with other triggering events). The buy-sell arrangment typically specifies:
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Triggering events: A clear definition of what constitutes a permanent disability or terminal illness that would initiate the sale.
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Valuation method: The agreed-upon formula or process for determining the business's value, which can be a fixed amount, a formula, or a regular professional valuation.
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Funding mechanism: How the purchase will be financed. The most common and effective method is through disability buy-out insurance or critical illness insurance, which provides a lump sum to the remaining owners to buy out the incapacitated owner's share.
Without a legally binding buy-sell arrangement, the business may be at risk of being dissolved, losing value, or facing legal disputes. If this is exacerbated by the business owner's lack of mental capacity to make legally binding decisions, the process under which a business owner might sell their interest in the business is made all the more difficult.
Key Considerations for the Business Owner
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Business Valuation: Get a professional valuation of the business to understand its worth. This is critical for setting the insurance coverage amount and for ensuring a fair price is paid in a buy-out.
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Power of Attorney: The owner should have a durable power of attorney to designate a trusted person to make financial and business decisions on their behalf if they become unable to.
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Estate Planning: The business succession plan must be integrated with the owner's overall estate plan to ensure assets are transferred as intended and taxes are minimized. This may involve setting up trusts or other legal structures.
Key Considerations for Co-Owners and Partners
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Operational Continuity: Have a plan for how the business will continue to operate without the key person. This may involve hiring a new manager or having existing partners take on additional roles.
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Funding: Ensure the buy-sell agreement is adequately funded. Relying on personal savings or bank loans to buy out a partner can be financially devastating. Disability buy-out insurance provides a tax-free payout that is a far more stable funding source.
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Tax Implications: Understand the tax implications of the buy-out. In a cross-purchase agreement, the remaining owners use the insurance proceeds to buy the shares directly, and the proceeds are typically tax-free. In an entity-purchase agreement, the business uses the funds to redeem the shares. It's essential to work with legal and tax advisors to structure the deal in the most tax-efficient way.
For knowledgeable and experienced legal representation when initiating, or being subjected to, a corporate buy-out, contact corporate business lawyer Christopher Neufeld at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.
