The importance of business succession planning

Akhona Modi, CFP®

Financial Planner, BDO Wealth, Johannesburg

Mr Smith started his manufacturing business in the early 1980s. Over decades, through hard work and dedication, he nurtured it into a multi-million-rand enterprise.

Recently, another South African company acquired a 52% stake in his business, a move that revealed his company’s significant value – and which took Mr Smith by surprise.

This made him reflect on his future, particularly his desire to retire and ensure that his family is well-provided for in his absence.

Mr Smith’s personal life is as complex as his business achievements. He was married for many years and had five children from that marriage. Unfortunately, his first wife passed away 15 years ago. Since then, Mr Smith has remarried, and his current wife brought four children from her previous marriage into the family.

He values transparency and believes it is crucial to communicate openly with his family about the family’s wealth and his plans for the future. He wants to avoid any potential conflicts or misunderstandings among his children by making sure that everyone is informed and on the same page.

Mr Smith wants to treat his stepchildren with the same love and fairness as his biological children.

Key concerns

Mr Smith’s main goal is to preserve the family’s wealth, especially given the substantial value of his business. He wants to make sure that the wealth he has accumulated over his lifetime is not only preserved but also managed in a way that will continue to grow and benefit future generations.

Succession planning is part of this, as Mr Smith wants to retire and hand over the reins of his business to the next generation – but he is also aware how complicated this can be, particularly when it comes to estate and tax planning.

He is keen to structure his estate in a way that minimises tax liabilities and ensures a smooth transition of assets to his heirs.

He wants to ensure that his wife, Jacky, has enough capital to live comfortably for the rest of her life, especially because she will not have a direct claim on the business assets. This, together with his desire to treat all his children fairly, including his stepchildren, requires careful planning and consideration.

Our approach

To address Mr Smith’s concerns, we took a comprehensive and multidisciplinary approach, drawing on expertise from various departments within BDO to provide a holistic solution and guidance to the family.

Our wealth advisory team was the single point of contact for Mr Smith, simplifying the intricate and often overwhelming processes of estate planning. We worked closely with our in-house attorney to draft and review trust deeds to make sure that they met Mr Smith’s estate planning objectives. This also involved updating wills for Mr Smith, Jacky, and his eldest son to reflect the current family structure and Mr Smith’s plans for his wealth.

To help minimise tax liabilities, our tax department did an in-depth analysis to work out the best share transfer options for Mr Smith.

Another important aspect of what we did was reviewing and optimising Mr Smith’s investment vehicles. We focused on investments that were not only tax-efficient but also well-structured to support his long-term goals, including minimising estate duty. Throughout this process, we made sure that we were open and transparent in our communication with Mr Smith and his family. We guided them through each step, so that they understood the rationale behind every decision and felt confident about the plans being put in place.

Outcome

The strategy we provided not only gave Mr Smith peace of mind, it also created a structure that preserves the family’s wealth and positions= it for growth in the future. The way we allocated his discretionary assets through a trust company structure, including compulsory and discretionary assets in his name, means that a bigger portion of Mr Smith’s assets will be passed on to his heirs.

Mr Smith’s wife won’t have a direct claim to the business assets, rather she is a beneficiary of his endowment and living annuity policies, which will give her enough capital to live comfortably.

Mr Smith’s children, including his stepchildren, are income and capital beneficiaries of the second family trust, which means that they will also be cared for and the family’s wealth will be shared fairly.

Mr Smith can now enjoy his retirement fully, without the burden of unresolved financial concerns. He spends his time traveling and at his beloved farm, content in the knowledge that his legacy is secure.

His eldest son is honing his leadership skills and has taken on an executive role within the business to help the company prosper in the future.

A QUICK GUIDE TO

BUY AND SELL AGREEMENTS

Akhona Modi, CFP®

Financial Planner, BDO Wealth, Johannesburg

Key questions

Do you have enough funds to buy your co-shareholder’s shares (or vice versa) in the event of their death or disability?
If not: Have you considered a buy and sell agreement funded by a life policy on the life of each co-shareholder? It is an essential mechanism for business continuity and protection.

Main elements of a buy and sell agreement:

Valuation of the business: A professional valuation should be done regularly to reflect the true value of the business. This is critical for determining the correct buyout price
Shareholding structure: Clarifies the shareholding percentages.
Trigger events: Death or disability of a co-shareholder.
Funding mechanism: Life or disability policies taken out on each co-shareholder’s life to fund the buyout.
Methodology: How the shares will be valued at the time of a trigger event.
Remaining shareholders: Obligated to buy the shareholding of the deceased or disabled shareholders.
Review and update regularly: The agreement and valuations should be reviewed periodically to reflect any changes in the business structure or value.
Funding for disability or critical illness: Consider extending the agreement to cover disability and critical illness policies to ensure business continuity in such events.

The policy must be referenced in the agreement, e.g., Policy PGH7890

Benefits of a buy and sell agreement

Wealth preservation: Protects the value of the business for remaining shareholders.
Financial security: Guarantees that the deceased’s family is compensated for their share of the business without causing financial strain on the business.
Succession planning: Ensures a smooth transition of ownership.
Tax efficiency: If structured correctly, buy and sell agreements can be exempt from estate duty (Section 3(3)(a)(iA) of Estate Duty Act).

Pitfalls of not having an agreement

Policies are counted as property: Without an agreement, or if the section 3(3) (a)(iA) exclusion requirements are not met, life policies are treated as deemed property in the deceased’s estate, subject to estate duty.
Estate duty exposure: The policy proceeds, minus the total premiums paid by the surviving shareholder (plus 6% simple interest), could be included as deemed property.
Disrupted succession and wealth preservation: Without a proper agreement, the surviving shareholders may not be able to buy out the deceased’s share, leading to family disputes and financial complications.