Co-owners structure their ownership interests in many ways. The impact of tax laws, specific industry regulation and an owner’s desire to protect their personal assets drives the decision on structure.
The common choices are:
- Unit Trust; and
- Joint Venture.
When established, co-owners should consider the typical risks arising in these relationships and enter into the “co-owners agreement”, addressing these risks, specific to their structure. When done properly, these agreements allow the owners to properly consider and set out their expectations of one another: “Why exactly am I going into business with you?”
Co-ownership agreements normally take the following forms:
- “partnership agreement” in partnerships;
- “shareholders agreement” in companies;
- “unitholders agreement” in unit trusts (shareholders and unitholders agreement where the trustee is a company, which is common); and
- “joint venture agreement” in joint ventures.
No matter what the structure is, there is one risk that applies: death or a co-owner. What will happen on the death of a co-owner? Are the surviving co-owners content that a deceased’s beneficiary under his will, say, his wife, will be their new partner? Will they agree to keep sharing profits, or other remuneration, even though the input of the deceased has ceased (presuming the deceased’s wife has not and cannot work, to the same extent, in the business)? Or, do the co-owners require a process where the deceased’s interest is transferred to the surviving owners and the deceased estate is compensated for its value. Whatever is required, its terms must be specified in a separate agreement called a “buy-sell agreement”.
Buy sell agreements specify events that will trigger co-owners (normally the deceased’s estate and the surviving owners) to force a transfer / sale of a relevant interest. Death is a typical trigger. The agreement will specify the period in which a sale can be forced, the price of the relevant share or how it will be valued, and when payment of the price is required.
As death may be unexpected, in many cases surviving co-owners will not have readily available funds to purchase the deceased’s interest from their estate. It could be a lot of money. To accommodate this, co-owners sometimes agree, in advance, to lengthy periods of time for payment, sometimes by instalments, depending on what funding they expect to be able to get, say, from a bank.
As an alternative, co-owners will often fund the sale with life insurance. Provided the co-owners can obtain insurance at reasonable prices, this option is often attractive. However, depending on the age and health of each co-owner, sometimes insurance is not economical or possible.
Where insurance is available, life insurance will be taken on their lives of each co-owner. When death strikes, the proceeds of that life insurance policy is applied by the surviving owners to acquire the deceased’s interest. The deceased’s estate end up with the money and the surviving owners end up with the deceased’s interest (e.g. shares in the company).
When co-owners use life insurance to fund buy-outs, consideration is given to the ownership of the insurance policy and the beneficiaries of the policy. Examples of insurance policy ownership and beneficiaries are:
- Self-ownership – where each co-owner takes insurance on their own life; on death proceeds are paid to that co-owner’s beneficiary (usually the deceased’s family) and the deceased’s interest in the business is transferred to the surviving owners;
- Cross ownership – each co-owner takes out a policy on each other; on death proceeds are paid to the surviving co-owners (who are the specified beneficiaries); the surviving co-owners use proceeds to fund purchase of deceased’s interest;
- Company owned – company takes out insurance on each co-owner (shareholder); on death of a shareholder, proceeds are paid to the company (who is the beneficiary); the company uses the insurance proceeds to buy-back the deceased’s shares from their estate.
- Trust owners – the trustee of the trust takes out insurance on each co-owner (usually a unitholder in a unit trust); on death of a unit holder, proceeds are paid to the trustee; the trustee uses the insurance proceeds to redeem the outgoing deceased units from their estate.
Each method will have distinct tax consequences to the owners, including capital gains tax on the transfer of the interest and tax deductibility of the insurance premiums paid. Financial advice on the best type should be sought. Where tax is payable on insurance proceeds, the owners should be careful to increase the insurance cover to accommodate it.
What do you need to do?
If you are starting business with others, contact us to discuss how we can help you address the common risks that affect “co-owners”.
Joe Kafrouni, Legal Practitioner Director, Kafrouni Lawyers
The information provided by Kafrouni Lawyers is intended to provide general information and is not legal advice or a substitute for it. Business people should always consult their own legal advisors to discuss their particular circumstances. Kafrouni Lawyers makes no warranties or representations regarding the information and exclude any liability which may arise as a result of the use of this information. This information is the copyright of Kafrouni Lawyers.
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