Business Succession Planning: What Happens to Your Business When You Die?

Why Business Owners Need Estate Planning

A standard Will, prepared without reference to your business structure, will almost never deliver the result you intend. There are three reasons:

• You may not own what you think you own. Shares in a private company sit in the estate. Units in a trust sit in the estate. But the assets inside a discretionary family trust do not — the trust owns them, and your Will cannot dispose of them. Superannuation does not automatically pass under your Will either. Many "business owners" hold almost none of the underlying value in their personal name.
• Control and ownership are different things. The shareholder of a company may not be its director. The unit-holder of a trust may not be its trustee. The member of an SMSF may not be the controller of its trustee company. A Will that deals with ownership but ignores control can leave the wrong person in charge.
• External agreements override your Will. A shareholder agreement, a buy/sell deed, a partnership agreement, a franchise agreement and a trust deed all rank ahead of testamentary intention. If your Will says "leave my shares to my daughter" but the shareholder agreement says those shares must first be offered back to the company, the agreement wins.

Business succession planning is the work of unwinding these conflicts in advance, so the documents tell the same story.

Sole Traders

A sole trader carries on business in their own name. There is no separate legal entity. On death the business, by default, simply stops. The assets (stock, equipment, goodwill, debtors) fall into the estate and are administered by the executor. Employees' contracts terminate. Customer contracts may or may not survive, depending on their terms.

For a tradesperson, consultant or single-handed professional, that is sometimes acceptable — the business is the person, and there is no business once the person is gone. But where there is goodwill, a client list, contracts in progress or staff, a sole trader structure is dangerous. We routinely recommend that sole traders with material goodwill either incorporate, partner up, or at least document in the Will the steps the executor is to take to keep the enterprise running, sell it as a going concern or wind it up in an orderly fashion.

The executor of a sole trader's estate inherits the practical responsibility — and the personal risk — of continuing trading without the proprietor. That is a role most executors are entirely unequipped for and should not be asked to perform without specific guidance and authority.

Companies

A company is a separate legal person. It does not die when its shareholders or directors die. What changes is the ownership of its shares and the identity of its directors.

On the death of a shareholder, the shares form part of the estate. The executor becomes entitled to be registered as the new shareholder, subject to anything the company's constitution or shareholder agreement says about transfers. Until the executor is registered, the shares cannot vote — which can be paralysing for a company with only one or two shareholders.

On the death of a director, the company must have at least one remaining director with capacity to act, or business effectively halts. For sole director, sole shareholder companies (extremely common among Victorian small businesses), the position used to be especially dire. The Corporations Act now allows the executor of a sole shareholder/director to appoint a new director and keep the company functioning — but only if the executor has been confirmed by a grant of probate, which takes weeks. In the interim, no-one can sign cheques, pay wages or enter contracts.

The clean solution is to appoint a second director (a spouse, an adult child, a trusted business partner) while the principal is alive, with a clear understanding of the role. The cost of doing so is essentially nil; the cost of not doing so can be the entire business.

Family Trusts

Discretionary family trusts are the most common business structure in Australia for small and medium enterprises, and the most commonly mis-handled in estate planning. Three points matter most:

• The trust assets are not yours. They are held by the trustee for the beneficiaries. You cannot leave them in your Will.
• The appointor controls the trust. The appointor (sometimes called the principal or guardian) typically has the power to remove and replace the trustee. Whoever holds the appointor power, controls the trust. That role is governed by the trust deed, not your Will — and many deeds are silent or unclear about what happens to the role on death.
• The trustee runs the trust. If the trustee is a company, the death of its sole director creates the same paralysis described above.

A proper succession plan for a family trust starts with a careful reading of the deed. We look at: who is the appointor; who succeeds the appointor; can the appointor power be exercised by Will; who is the trustee; what happens if the trustee company has no remaining director; who is in the class of beneficiaries; and whether the deed contains a vesting date that will force the trust to wind up earlier than expected. Almost every legacy trust deed we review needs at least one amendment to be fit for modern succession purposes.

Self-Managed Superannuation Funds (SMSFs)

SMSFs sit at the intersection of business, retirement and estate planning, and are governed by their own deed plus the Superannuation Industry (Supervision) Act. The critical issues on a member's death are:

• Trustee continuity. The deceased member's legal personal representative usually steps into the trustee role for a limited period. Where the fund has a corporate trustee, the directorship needs to be re-constituted promptly to maintain compliance.
• Death benefit nominations. A binding death benefit nomination — if current and valid — compels the trustee to pay the deceased's benefit to the nominated dependants or to the estate. Without one, the trustee has discretion. Disputes between surviving spouses (especially in blended families) and adult children of an earlier relationship are the bread and butter of SMSF litigation.
• Liquidity. If the SMSF's main asset is a commercial property leased to the family business, the fund may not have the cash to pay a lump-sum death benefit. The succession plan needs to deal with that — typically through life insurance inside super, or a clear plan to sell or transfer the property.

An SMSF without a current binding nomination, reviewed alongside the member's Will, is almost always an SMSF with a problem waiting to happen.

Shareholder Agreements

A shareholder agreement is the rulebook between the co-owners of a company. For succession purposes, the key provisions are:

• Pre-emptive rights. Existing shareholders are usually given the right to buy a deceased's or departing shareholder's shares before they can be transferred to anyone else.
• Permitted transferees. Some agreements permit transfers to family members or a family trust; others do not. This must be aligned with what the Will contemplates.
• Valuation mechanism. How is the price of the shares to be determined on a death-triggered sale? Independent valuation? An agreed formula? The last filed accounts? The price mechanism, more than any other clause, determines whether the surviving family receives fair value.
• Funding mechanism. Where the agreement requires the remaining shareholders to buy the deceased's shares, where will they find the cash? Without a funding plan — typically insurance — the clause is unenforceable in practice.
• Dispute resolution. Mediation and arbitration clauses keep disputes out of court and, in family businesses, can save relationships as well as money.

We routinely see businesses with no shareholder agreement at all — sometimes between siblings, sometimes between unrelated co-founders. The cost of preparing one is small. The cost of fighting without one, after a death, is many multiples larger.

Buy/Sell Agreements

A buy/sell agreement is a specialised contract between business co-owners that activates on certain "triggering events" — most commonly death, total and permanent disability or critical illness. Its purpose is to ensure that when a triggering event happens:

• The departing owner's interest passes to the continuing owners (and not, for example, to the deceased's spouse who has no role in the business);
• The departing owner's family receives an agreed, funded price for that interest; and
• The transition is automatic and unconditional, with no room for renegotiation at a vulnerable moment.

Buy/sell agreements typically take one of three forms: put options (the deceased's estate can compel the continuing owners to buy); call options (the continuing owners can compel the estate to sell); or — most commonly — automatic put-and-call structures.

Funding usually comes from life and TPD insurance policies, owned either by the individual owners ("self-ownership") or by a separate insurance trust. The tax treatment, accounting treatment and asset-protection outcomes of each option differ materially and require joint legal and accounting input.

Key Person Insurance

Key person insurance is a different concept from buy/sell cover. It is a policy owned by the business on the life of an individual whose death or disability would cause the business material financial loss — typically a founder, top salesperson, lead practitioner or technical specialist.

The proceeds, paid to the business, are used to:

• Repay business debts that the key person guaranteed;
• Fund recruitment and training of a replacement;
• Cover the loss of revenue while the business transitions; and
• Reassure suppliers, customers and lenders during a vulnerable period.

For owner-operated businesses, key person and buy/sell cover often operate together, on separate policies, with separate purposes. The structures should be reviewed together to avoid double-counting cover or leaving an uninsured gap.

Passing Control of Family Businesses

Family businesses introduce a layer of complexity that purely commercial succession does not: the children who work in the business, the children who do not, and the spouse caught in the middle.

The honest position is that "equal" and "fair" are rarely the same thing in family business succession. Leaving the business equally to three adult children when only one of them works in it is a recipe for conflict — the working child resents subsidising passive siblings; the non-working children resent being dependent on their sibling's competence and goodwill. The cleaner solutions usually involve:

• Passing the business (or controlling interest) to the working child or children, and equalising other children with non-business assets — typically real estate, superannuation or life insurance;
• Using a testamentary trust to hold the business interest, with the working child as appointor;
• Building a phased transition over five to ten years while the parent is still alive, with formal governance, board meetings and external advice; and
• Documenting all of it transparently — most family business disputes are about being surprised, not about being disadvantaged.

The single most useful thing a family business founder can do is to start the conversation early, in writing, with everyone in the room.

Succession Planning for Professional Practices

Professional practices — legal, medical, dental, accounting, allied health — have their own succession challenges. The practitioner's name and qualification are inseparable from the value of the business. Restrictions on ownership (only a lawyer can hold legal practice shares, only a doctor can hold medical practice goodwill) limit who the business can pass to.

The usual planning tools are:

• Pre-arranged practice sale. A binding arrangement with a colleague, a competitor or a corporate buyer that on death or incapacity the practice will be sold to them at an agreed price or formula.
• Locum and run-off provisions. A clear plan for who covers the practice in the weeks between death and sale, including client communications and file transitions.
• Run-off professional indemnity insurance. Cover for claims notified after the practitioner has ceased practice. Without it, the estate is exposed for years.
• Client and patient continuity. Notice requirements, file retention rules and regulator obligations — all of which differ by profession.

For partnerships, the partnership agreement should specifically address dissolution on death, valuation of the deceased partner's interest, and how that interest is paid out over time.

Tax Considerations

Tax issues sit underneath every business succession plan. The most important are:

• Capital gains tax (CGT). The transfer of an asset from a deceased estate to a beneficiary generally does not trigger CGT — the beneficiary inherits the deceased's cost base (or market value at date of death, for pre-CGT assets). But a subsequent sale by the beneficiary does trigger CGT. Planning for the eventual sale is as important as planning for the transfer.
• Small business CGT concessions. The 15-year exemption, the 50% active asset reduction, the retirement exemption and the rollover relief can — between them — eliminate CGT on a sale of an active small business asset. They have strict eligibility rules (turnover, net asset value, holding period, active asset use) which need to be planned for years in advance.
• Superannuation death benefits tax. Death benefits paid to a tax-dependant (spouse, minor child, financial dependant) are tax-free. Death benefits paid to a non-tax-dependant (typically an adult child) attract tax at up to 17% on the taxable component. For SMSFs with large balances, the difference can be six figures.
• Insurance and CGT. Life insurance proceeds are generally CGT-free in the hands of the original policy owner or their estate. But where a buy/sell agreement uses cross-ownership of policies, CGT consequences can arise. Structure matters.
• Trust losses and trust resettlement. Amendments to a trust deed, including those made for succession purposes, can in some cases be treated as creating a new trust — with the loss of carried-forward losses and the triggering of CGT and stamp duty. Deed amendments should always be done with both legal and tax advice.

Common Mistakes

The recurring mistakes we see in Victorian business succession files are entirely avoidable:

• A "personal" Will that ignores the business. A standard Will leaves "all my estate" to a spouse, with no attention to who runs the company, who controls the trust or who holds the SMSF directorship the next morning.
• Sole director, sole shareholder companies. The simplest succession trap of all, and the easiest to fix.
• An outdated trust deed. A deed drafted in the 1980s, never reviewed, with no successor appointor and a vesting date the founder will likely outlive.
• A non-binding death benefit nomination. "Preferred" nominations leave the trustee with discretion — and the family with uncertainty.
• A shareholder agreement no-one has read since signing. Pre-emptive rights, valuation mechanics and funding clauses that no longer reflect the parties' intentions or the business's value.
• Insurance held inside the wrong entity. A buy/sell policy owned by the wrong person can defeat the entire arrangement and create unexpected CGT.
• No conversation with the next generation. Assumptions about who wants to run the business — made by the parent, never tested with the children — that turn out to be wrong.
• Treating the business as a single asset. Operating company, land-holding entity, intellectual property holder and SMSF lessor are usually different vehicles with different succession considerations.

Case Studies

The following examples are composites drawn from common fact patterns. They are illustrative only.

Case 1 — The sole director. A fifty-eight year old founder of a successful Melbourne freight company is the sole director and sole shareholder of the operating company. He dies suddenly. His widow and adult children cannot sign the wages cheque on Thursday because no-one has authority to operate the business bank account. By the time probate is granted six weeks later, three key drivers have resigned and the largest customer has moved its contract to a competitor. Outcome: the business sells for a third of its value twelve months later. What would have fixed it: a second director, appointed years earlier, with clear instructions.

Case 2 — The unread trust deed. A family business has operated through a discretionary trust for thirty years. The founder's Will leaves "everything to my three children equally". On her death the children discover that the trust assets — the entire family wealth — are not in the estate, and that the appointor power has, under a clause no-one remembered, passed automatically to her second husband. He is now in legal control of the trust that holds the family business. Litigation runs for two years. What would have fixed it: a deed review and a succession amendment, completed in an afternoon.

Case 3 — The undocumented partnership. Two unrelated co-founders run a profitable consulting firm 50/50. There is no shareholder agreement, no buy/sell, no insurance. One partner dies. His widow inherits his 50% and, with no commercial relationship to the surviving partner, wants to be paid out at full market value immediately. The business has no cash. The surviving partner has no funding source. The dispute ends in a forced sale of the business and the loss of the goodwill both had spent twenty years building. What would have fixed it: a buy/sell agreement funded by life insurance, costing a few thousand dollars per year.

Case 4 — The successful succession. A second-generation manufacturing business, jointly owned by a father and his two adult sons, with a written shareholder agreement, life and TPD insurance funding an automatic buy/sell, an updated trust deed, current binding death benefit nominations, and Wills that dovetail with all of the above. When the father dies unexpectedly at sixty-six, the transition is complete within ninety days. The widow receives the agreed insurance proceeds. The sons own the business outright. The staff and customers see no disruption. What made the difference: the time the family had spent two years earlier, sitting around a table with their lawyer and accountant, doing exactly this work.

Frequently Asked Questions