Planning is crucial in turning a deceased spouse's business into usable family capital

Question:

My spouse is a 50% shareholder in a business that generates a consistent profit of R6-million a year. I am concerned about what would happen should he pass away. What would happen to the income we get from the business and would there be any estate duty implications?

Answer:

A business may make R6-million profit a year, but this does not automatically mean your family is entitled to keep receiving that income if your spouse dies. What you receive will depend on:

• the legal structure of the business;
• the partnership or shareholders’ agreement;
• the buy-and-sell agreement;
• the will; and
• whether there is enough liquidity to turn your spouse’s business interest into cash.

The question is not only what the business is worth. The more important question is how this value gets converted into income for the surviving spouse.

This is where many plans fall apart, and it’s the reason every business owner should have three documents that relate to each other: a will, a shareholders’ agreement and a buy-and-sell agreement.

A properly structured buy-and-sell agreement says, in effect, that if one director dies, the surviving directors must buy the deceased director’s interest and the deceased director’s estate must sell it.

It is usually funded by life cover. The surviving directors receive the insurance proceeds, which they use to buy the deceased director’s share from the estate. This gives the surviving spouse cash rather than an illiquid business interest. It also allows the remaining directors to run the business without the deceased director’s family becoming unwilling or unsuitable co-owners.

Value of the business

A common way to value a business is to apply a multiple to maintainable annual profit. For smaller private businesses, a rough range is three to five times maintainable profit.

On this basis, a business generating ­consistent profit of R6-million a year could have an indicative value of between R18-million and R30-million. If your husband owns 50% of the business, his shares may be worth between R9-million and R15-million.
This can create estate duty, executor’s fees and liquidity problems.

What should you do?

Establish what your spouse’s business interest is worth. Get it done professionally. A valuation should look at maintainable earnings, business structure, debt, reliance on key individuals, recurring revenue, client concentration, and whether the profit would continue if your husband was no longer there.

Next, check the legal agreements. Does a partnership or shareholders’ agreement exist? Does it say what happens on death?

Then check the funding. If the surviving directors must buy your spouse’s share, where will the money come from?

My practical advice is do not wait for a crisis. Ask your spouse for a family financial continuity meeting. This is not about mistrust. It is about protecting you, the business partners, the employees and the business itself. The meeting should involve your financial planner, accountant and attorney. It should answer four questions:

1. What is the business worth?
2. What income would the family need?
3. Who buys the business interest on death?
4. Where does the cash come from?

The goal is to turn business value into usable family capital, without damaging the business or creating unnecessary estate duty and tax problems. This does not happen by accident. It happens by planning. DM

Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to kenny.meiring@sfpadvice.co.za