Have you ever thought of what would happen to your interest in your pharmacy business if you suddenly died or became permanently disabled? Have you ever wondered what would happen if either of these sudden events happened to your business partner?
Could you afford to buy their interest out? Have you and your business partners agreed on the procedure to be followed if a partner wishes to exit the business or retire?
Partners in a pharmacy business, whether operating through a partnership, a trust, a company or a combination of these need a business succession strategy which deals with the exiting, death, total disability, bankruptcy or retirement of a party. Younger partners may also wish for the strategy to contemplate the compulsory buy-out of senior partners on the happening of certain trigger events (i.e. attaining a certain age).
A business succession strategy should be set out within a partnership or shareholders agreement or formalised under a separate legally binding document between the parties (i.e. a Business Succession Deed). Either way, it is important that the strategy deals with the following:
The death or permanent disability of a partner –
If a business partner dies, then under the Pharmacy Regulation Act 2010 (Vic) (and generally under equivalent legislation in other States and Territories) the executor of their estate is only able to carry on the pharmacy business for six months (or such other period as the Victorian Pharmacy Authority permits). This means that the executor will need to sell the deceased pharmacist’s interest in the business quite quickly. If the pharmacist becomes permanently disabled, then the pharmacist’s registration would lapse and similar issues would arise.
This creates three primary issues. Firstly, the remaining partner/s may not be in a financial position to buy out the departing partner’s interest on short notice or at all. Secondly, the need to complete a quick sale may mean that the estate does not receive fair value for the business interest. And thirdly, the remaining partner/s may not wish to partner with the third party pharmacist that purchases the departing partner’s interest.
To mitigate these issues, a business succession strategy should provide for the business to take out death and permanent disability insurance (for all partners) with sufficient coverage to allow the remaining partners to buy out the departing partner’s interest using the proceeds of the insurance.
The level of insurance should be reviewed annually and should take into account:
- the changed value of the business;
- loans from the partners to the business; and
- further amounts required to stay within the business to copy with the loss of the partner.
The exiting or bankruptcy of a partner –
A process needs to be set out to deal with the interest of a partner who wishes to exit the business or who becomes bankrupt. Generally, if any of these events happen, the remaining partner/s should be given an option to purchase the interest of the departing or bankrupt partner prior to the interest being offered to third parties.
A primary issue to be agreed upon is the method for valuing the business. As the departing partner will likely be important to the business, whether or not a discount to market value (say 20%) is factored into the valuation should be considered. A further issue to be agreed upon is the terms of the sale – will the purchase price be paid in full on settlement or will an ‘earn out’ arrangement be put in place?
The retirement of a partner –
The strategy should set out a process which enables older partners to divest their interest in the business on their retirement. Conversely, younger partners may wish for certain trigger events (i.e. a partner reaching a certain age) to create an option for them to buy-out older partners – we have all heard of the horror stories of the older partner who seems to have retired, but keeps on collecting.
Often a sensible way to deal with the need of the older partner to cash-out and the inability of the younger partner to finance the buy-out is for an earn-out arrangement to be included in the business succession strategy. In general, an earn-out arrangement will allow the retiring partner to reduce their workload as their interest in the business is gradually bought out by the younger partner, for example over a 5 year period. During this period the retiring partner will receive profit distributions which will gradually reduce as their interest is brought out.
A thought out, agreed and formalised business succession strategy will give comfort to all partners. We cannot stress the importance of formalising a business succession strategy before issues arise. Pointon Partners has significant experience in dealing with business succession planning and would be pleased to assist with your needs. In this regard, please feel free to contact either Michael Bishop or Aaron Zoanetti on (03) 9614 7707.
by Aaron Zoanetti – Lawyer, Pointon Partners