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Buy-sell agreements – Part 2

buy-and-sell agreements

In the last week’s article, we introduced you to the concept of buy-sell-agreement-life-insurance
buy-sell agreements. In this article, we have a look at some practical examples of how these agreements and policies are physically implemented.

A re-cap of the importance of a buyout agreement

  • Forms a critical component in the business planning phase as it regulates what happens on the death (or possible disability) of a business partner
  • Without an agreement in place, a surviving partner might find himself having to work with an unwelcome relative of the deceased or a stranger to whom the executor has sold the deceased’s shareholding.
  • Likewise, business partners want the security of knowing that upon their death, their estate will receive the due compensation from such an agreement for the sale of their shareholding. Their dependents will ultimately need these proceeds to meet their needs after his/her death.

Example

Assume a company has 3 shareholders and the value of the company is R6 million. Shareholder 1 has a 50% share in the company, shareholder 2 has a 20% share, and shareholder 3 has a 30% share. The life insurance policies required in terms of their buyout agreement would be as follows:

Policy   Holders

Life   Insured

Sum
Insured

Shareholder 2
&
Shareholder 3

Shareholder 1

R3,000,000

(50% of R6m)

Shareholder 3
&
Shareholder 1

Shareholder 2

R1,200,000

(20% of R6m)

Shareholder 1
&
Shareholder 2

Shareholder 3

R1,800,000

(30% of R6m)

 

Important note

It is possible for the company to pay the monthly premiums for ease of administration. It is however critical that in order to qualify for the estate duty exemption and relevant Capital Gains Tax exemption, the company recovers this from each respective shareholder by way of a loan account or deduction from his/her salary.

Now that we have determined the values of the policies that have to be taken out on each shareholder’s life, how do we know what amount each shareholder has to contribute to the premiums on each policy?

Calculation of ownership splits on each policy

This is calculated according to the ratio of shareholding within the company. If we use the above-mentioned example, the ownership split in respect of each of the 3 policies would be as follows:

 

Policy   Holders

%   Ownership of Policy

Shareholder 2:
20/50 x R3m = R1,2m

&

Shareholder 3:
30/50 x R3m = R1,8m

Shareholder 2 owns 40% of the policy
(on shareholder 1’s life)

&

Shareholder 3 owns 60% of the policy
(on shareholder 1’s life)

Shareholder 3:
30/80 x R1,2m = R450,000

&

Shareholder 1:
50/80 x R1,2m = R750,000

Shareholder 3 owns 37,5% of the policy
(on shareholder 2’s life)

&

Shareholder 1 owns 62,5% of the policy
(on shareholder 2’s life)

Shareholder 1:
50/70 x R1,8m = R1,278,000

&

Shareholder 2:
20/70 x R1,8m = R522,000

Shareholder 1 owns 71% of the policy
(on shareholder 3’s life)

&

Shareholder 2 owns 29% of the policy
(on shareholder 3’s life)

 

These percentages of ownership of each policy would therefore also determine the % of the premium each of the shareholders has to contribute towards the premiums of each policy, which would, in turn, be allocated to each shareholder’s loan- or salary account.

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