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62. How to secure a pension-providing business

Question: My husband and I are in our mid-sixties and live off the profits from a small company that employs 20 people. We are still involved in the day-to-day management and plan to do so until we turn 70. My husband is the only shareholder. Is there anything that we should be doing to ensure that the business is able to provide us with a sustainable income when we ‘retire’.

Answer: This is a very relevant question as many owners of small businesses have given sufficient thought to the long-term risks that they are exposed to.

Risk 1 – 100% ownership by one person 

As your husband is the only director of the company, what would happen should he die or become mentally incapacitated? 

With the loss of a shareholder, the business could carry on its operations.  However, with the loss of the sole shareholder, there would be no-one who has the executive authority to negotiate contacts or institute legal proceedings.  The business would effectively be rudderless for a couple of months while an executor is appointed.  The executor would then need to approve a successor.  This could take up to a year to sort out – which could place the business at risk. 

In the case of your husband becoming mentally incapacitated (and we are seeing this more and more because people are living longer), the process will take even longer as a court application for a curator will be needed. 

There are a number of simple solutions to this.   

You could, for example, become a shareholder in the business so there is someone to take over the executive management should your husband pass away or become mentally incapacitated. 

Another option is to have your husband as sole director of the company pass a resolution that nominates an authorised representative to take over the executive management of the company in the event of his death or mental incapacity.  This is a simple solution that can have a big impact. 

Insider tip:  

Do not rely on giving someone power of attorney to deal with dementia.  All powers of attorney fall away when dementia is diagnosed.   

Risk 2 – no succession plan 

As you and your husband are still deeply involved in the day-to-day management of the company, what are you going to do over the next five years to ensure that you have groomed one or two people to take over from you and ensure that they actually stick around and not join a competitor? Your pension after the age of 70 will depend on whether you can groom and retain the right people. 

You need to take a good look at your current staff compliment and see if there is anyone there who can run the company in the future. If there is, then you should spend time and money in providing the necessary training in capacity building to ensure that the business will be in good hands going forward. 

The big challenge you are going to have is how to retain this person in your company. A number of companies make use of a structure called a preferred compensation plan to deal with this issue. 

Preferred compensation 

Briefly, this preferred compensation plan works as follows:

  • The business enters into an agreement with the designated employee where the business grants a salary increase on the condition that increase, less tax, is used to fund an endowment policy
  • The employee signs a collateral cession, that allows the employer to call up the cession and the funds should the employee leave the service before the agreed timeframe.
  • When the policy matures in 5- or 10-years’ time, the cession will be cancelled and lump sum will be paid across to the employee to buy shares in the company.
  • There are a couple of controls that you should put into the agreement.  For example, you can state that should the employee resign before the maturity date, the company may surrender the policy and keep the proceeds.  You can also link the payment to certain short- and long-term goals being achieved.

There are tax benefits:

  • The company will be able to deduct the entire contribution as employee earnings.
  • Upon maturity, there is no additional tax payable on the maturity proceeds.

This type of structure is a great way to retain top people in the company and align their goals with yours.  It also provides you with a nice vehicle to extract some capital from the business.  

These are specialised products and you do need the right legal agreements in place to ensure that it is legally robust.  Speak to a financial planner who is familiar with these structures.