Christopher Jackson, Financial Times

You and your partner have owned a successful business for several years. One evening your partner complains of chest pains and a few days later he dies of a heart attack.

What happens to you and your business? Without a current buy-sell agreement and adequate life insurance, you may not have a business at all.

Without such plans, your late partner's shares pass to his estate which distributes them to his relatives, spouse and favorite charities. Suddenly you find you are in business with someone you don't know - and who doesn't know you. The new owner may be able to sell his shares to someone else, at the best price he can get, and may well do so without concern for your interests. Key employees, suppliers, customers and creditors can become nervous. Unsecured creditors may press for faster payment. Any banker concerned about his retirement will think twice before renewing credit lines. Without warning people who unquestioning loyalty you had commanded are pressing you on all sides with their concerns and your business starts to seem much less secure. Worse still, you have lost perhaps the only other person who understood the business as thoroughly as you do and on whose business experience and personal qualities you relied completely.

All this doesn't have to happen if you plan correctly. If you partner dies, it is usually best for all concerned if his business interest passes to you, not to a family member who may not want to own it or know ho to handle it.

To make sure of this, you should have a buy-sell agreement, a document that requires each partner to sell his interest to the other partner, and requires the other to buy it. The agreement will also set out the worth of your business and tell how to evaluate it exactly if a part is to be sold. Thus the business can survive the death of a key person and keep the same management, while your partner's family will get the full value for his share of the business.

Valuing the business is a key feature in this buy-sell agreement. If it's a fairly new company, value should perhaps be based on an agreed floor value, though market value should also be taken into account because it affects capital gains liabilities. Businesses are commonly valued on their earnings history. Don't base the value on a single year's earning, though. If you have a bad year, it could mean less money for the estate. Financing a buy-sell agreement is critical.

If you partner dies, where do you find the money to quickly buy out his interest? Unless a business has large cash reserves you'd have to either finance the purchase out of future profits, or borrows the funds. Such solutions have severe disadvantages. If the business encounters difficulties, it may be unable to meet its obligations no matter what the agreements says. Such arrangements weaken the balance sheet and reduce cash flow.

Borrowing may be a problem if a lender is reluctant to commit after the death of a key person. Life insurance may be the best method to guarantee the necessary funds without increasing your obligations or affection cash flow. Your circumstances will determine the insurance arrangements but the idea is to have enough to buy out the stock of a deceased partner.

You and your partner can both have insurance on each other's lives so that if one dies, the other can use the proceeds to buy the partner's interest from his estate and vice versa. If you business is incorporated, you have even more scope. Individual shareholders may insure each other, just like partners. The disadvantage here is that each shareholder must pay life insurance premiums personally.

A better method is to have the company own and pay for the insurance. When a shareholder dies, the insurance proceeds are paid to the company, which in turn pays them to other shareholders so they can purchase the dead shareholder's shares from his estate.

Another solution is for the company to purchase the shares directly from the deceased shareholder's estate, thus increasing the proportionate holdings of the surviving shareholders. Consider having power of attorney for each principal business owner as well. If you partner is incapacitated for a length of time, such a precaution might prevent delays in making crucial business decisions.

Conditions change rapidly in business, so review all such agreements and insurance arrangements annually to ensure they meet your needs and have not been affected by changes in legislation.

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