In this Part 3, let's look at the general structure of a Business Value Protection Trust (BVPT) plan and what would be the funding options for a business owner to buy-out the other business owner. In my previous article, the idea behind BVPT is to protect the value of the business so as to ensure fair and agreed price for the outgoing business owner or his family. At the same time, the remaining business owner(s) (who are the purchaser(s)) will be able to continue with the business without any disruption from unqualified and/or inexperienced family members.

GENERAL STRUCTURE OF BVPT

The diagram below shows the steps for a BVPT.

Let me give you an example, where Ismail, Chong and Ramesh are shareholders in ICR Design Services Sdn. Bhd. which provides designs and construction services for homes and offices. The business is thriving and last year, the company had a net profit of RM5million. Ismail is a 40% shareholder, whereas both Chong and Ramesh own 30% each. All of them are married and have children. However, all of them agree that their family members should not be involved in the business. This is because their wives are working elsewhere with their own careers and their children are still very young. Ismail is 40 years old, Chong is 35 years old and Ramesh is 38 years old. All of them at this moment do not have any pre-existing medical condition that would prevent them from being insured.

The BVPT plan was introduced to them by a Professional Estate Planner of Rockwills. They are keen because it makes it very easy for them to sell their shares to the others without having to discuss on the pricing and the purchasers would not be financially drained to pay for the purchase.

To start, Ismail, Chong and Ramesh would need to agree on the value of the business. The purpose of the valuation is to establish a method for determining a purchase price for the ownership interest and avoids costly disputes over its values. There are many ways to value the business and it may be necessary for Ismail, Chong and Ramesh to engage an accountant to conduct a valuation or agree on the formula to be used to value the business in the future or to have an agreed price which is subjected to be reviewed periodically.

Once the valuation method is sorted out between them, another critical issue would need to be determined - funding to purchase in the future. Unless Ismail, Chong and Ramesh have a huge cash reserve of their own, it would be difficult for them to buyout the shares when one of them exits. In my opinion the easiest way to fund such a purchase is by way of life insurance policy. The Professional Estate Planner will provide the necessary advice to Ismail, Chong and Ramesh on the type of life insurance (except for Keyman insurance) most suited for BVPT.

How will Ismail, Chong and Ramesh be able to pay for the insurance premiums? Part or all of the premiums may be paid through the dividends received as shareholder and/or director's fees. However, the company itself cannot be paying the premiums (whether it is categorized as deductible or non-deductible expenses) as it would contravene section 67 of the Companies Act 1965. For private limited companies, the company is not allowed to buy back its own shares or directly or indirectly providing financial assistance to the shareholders to purchase the shares of another shareholder.

Regardless of the type of life insurance (except for Keyman insurance), each of the eligible shareholders shall be insured. If all of the shareholders are insurable, then it is best that the first (1st) party method is to be used. This means Ismail will insure himself (and he is the policy owner-life assured) whereas both Chong and Ramesh pays for the premium of Ismail's policy. The same method is used for Chong and Ramesh's policies. This method is preferred as opposed to third (3rd) party method (commonly known as cross purchase) where Ismail will insure the life of Chong and Ramesh. Ismail will also pay for the insurance premiums for both policies. Another method is third (3rd) party method (commonly known as cross purchase) where Ismail will insure and pays for the premium on the life of Chong and Ramesh. However, 3rd party method may give rise to issues of insurable interest (to prevent a policy owner to gamble on lives of others commonly known as moral hazard) and multiple policies requirement. Generally the 1st party method of insurance is the choice recommended.

If Ismail, Chong and Ramesh are insurable, the funding structure is as illustrated in the diagram below. Once the policies are enforced, each of them shall assign the policies to the Trustee.

If Ismail or anyone of them is not insurable due to health reasons, the ownership of the policies will be different. The diagram explains how to structure the insurance ownership when one of the shareholders is not insurable, which uses a 3rd party method. Alternatively, Chong and Ramesh could start a sinking fund right now or pay all of it by cash when the time comes to buy-out Ismail's shares.

When one of the shareholders is not active in the business and that shareholder has no intention to purchase the shares of the others, then the funding structure would be different as shown in the diagram below. Let's assume Ramesh is merely a shareholder who invests but he is not active in the business. He is also not a Director of the company.

Each policy owned by Ismail, Chong and Ramesh is to be assigned to the Trustee. This would enable the Trustee to claim and to receive the insurance proceeds when an unfortunate event such as death or disability or critical illness befalls one of the shareholders. The advantage of incorporating the Trust into BVPT is to ensure that the proceeds are received by an independent party as well as to distribute the proceeds to the outgoing shareholder or his family avoiding the need to apply for Probate, in the event of death. The Trust would be most advantageous when a shareholder dies because it contains instructions to the Trustee how to distribute the proceeds as there is no need to distribute all the proceeds to the beneficiaries at one time but a structured distribution can be designed. This prevents the beneficiaries misspending the funds.

Once the insurance funding is sorted out and put in place together with the other components of BVPT i.e. the agreement, power of attorney and trust deeds, upon death of one of the shareholders, the Trustee would claim the sale proceeds from the insurance company and transfer the shares of the outgoing shareholder using the power of attorney given by the shareholder to the Trustee. The beneficiaries of the deceased shareholder shall receive the sale proceeds in accordance with the terms of the agreement and distributed according to the terms of the trust deed.

This is shown in the diagram below.

In the penultimate part, the contents of the agreement for the BVPT will be examined together with the usage of cross option for BVPT.

To set-up a BVPT, it takes time and various legal and practical issues would need to be examined, so it would be wise to engage the services of a Professional Estate Planner to do so.

This is an article prepared by Azhar Iskandar Hew, General Manager. Rockwills Trustee Berhad

Rockwills Trustee Berhad provides a wide range of Private Trustee and Estate Planning services, including Business Value Protection Trust. Rockwills Trustee is part of the Rockwills International Group and is an associate company of Rockwills Corporation Sdn Bhd, the No. 1 Professional Will Writing Company in Malaysia. Azhar can be reached at 03-77811993 or at azharhew@rockwills.com