Many people own a share of a small business. This ownership interest is usually in the form of a shareholding in a private company, or a member’s interest in a close corporation.
I expect to see an increasing number of business owners in the future, given the favourable tax treatment that small and medium enterprises now enjoy. The government is hoping to drive economic growth through small business, much like the successful model used in the state of California.
I often see a serious lack of financial planning when it comes to small business ownership. It is understandable to some extent, as the owners’ priorities in the first few years are usually to get the business up and running. It can be a struggle to survive from month to month, never mind thinking strategically about the future.A well-structured shareholders’ agreement should be put in place. This sets out how a shareholder will exit the business and what valuation will be placed on the shareholding.
It is a good idea to have a clearly stated predefined valuation method — this can prevent nasty disputes, as business valuations are notoriously subjective.
The most common valuation method is to multiply a sustainable profit figure by an appropriate earnings multiple. The earnings multiple will depend on the nature of the industry that the business operates, and on assets.
It is also important for small business owners to have a buy and sell agreement in place. This obligates an owner to sell his or her interest to the surviving members in the event of death or permanent disability. The surviving members are in turn obligated to use the proceeds of an insurance policy on the life of the deceased to purchase the interest.
This facilitates a clean and speedy resolution to a very unpleasant situation. Surviving owners do not have to scratch around for finance, or take on the deceased’s spouse as a business partner. The spouse may well lack the skills or interest to get involved in the business in any event. The deceased’s estate would benefit greatly from a speedy settlement at fair value.
It is fairly common for a successful business to be heavily reliant on a single individual, usually the founder. Key person assurance would provide protection for the company in the event of the death or permanent disability of this person. An insurance policy would provide immediate funds that could be used to recruit a suitable replacement, or simply provide vital cash flow during a very disruptive time.
The final financial planning issue that may need to be considered is surety or debt cover. Business owners are often required to stand surety for the debts of the business. Should the business be unable to pay its debts, the owner will be personally liable.
In the event of the death or disability of a business owner, creditors may become nervous about the ability of the business to repay its debts. They might decide to call in debts. This could obviously have a devastating effect on the viability of the business.
Surety cover will provide the company with much-needed funds to keep creditors at bay. The business owner’s estate will also be released from any claims that the creditors may have against it.
It is important to structure the above-mentioned insurance products in the correct way, from both an income tax and estate duty perspective. Speak to a qualified financial planner to decide what strategic financial planning issues should be considered in your company’s circumstances.
Visit the website www.fpi.co.za to select a qualified, certified financial planner.
Debbie Netto-Jonker CFP®, founder of Netto Invest, was Financial Planner of the Year in 2001.
By Debbie Netto-Jonker CFP®
