Are you protecting your continued ownership of your business?
Keeping hold of your money can be hard in business - but keeping hold of the ownership of your business can be harder. Simply put, Protecting Business Ownership is about protecting the business owners and their families from a forced change in ownership due to financial stress.
This is because business owners, businjess partners and business families, together have a vested interest in the continuation of their business and maximizing its value - whether that's to continue to produce revenue or to sell later when they choose, as a viable ongoing concern.
What is Business Partnership Ownership Protection?
When people make the decision to go into business together, one important yet often overlooked consideration is how best to establish and document the legal relationship between them.
- Business Partnerships often start out as informal arrangements where individuals work with each other on shared projects.
- Multi Owner Businesses are usually company structures where the ownership percentage of the company is clearly determined by the number of shares individually held.
While one of the key benefits of a general business partnership is it allows the Partners to pool their respective skills and resources (skilled labour, financial resources, business relationships, equipment etc.), they also need to address how to manage the risks of unlimited personal liability, for the other Partners actions.
Different business structures have different risks to manage
Owning a business in a Partnership structure means all the business Partners need to protect their portion (equity investment) in the business to make sure the future control of the business stays with them.
Owning a business with a Company structure, perhaps with multiple owners, means all the business owners have similar challenges and need to protect their own portion (equity investment) in the company to make sure the future control of the business stays with them.
- A forced change in ownership in either of these business structures, for example, due to one or more of the partners or owners suffering a serious motor vehicle accident, ill health or unexpected death could destabilise the business and risk its future for all concerned.
Key questions common to Partnership and Company structures
When transferring the ownership of part of a business to others, how will that happen and who will pay for it?
- How will the remaining business owners buy out the share of the business owned by the departing (perhaps now deceased) owner?
- What would happen if that share of the business was sold to a competitor?
Losing an owner from the business may mean losing control of the business to a competitor or suddenly finding you’re now in business with an heir to the departed owners estate, who may not have the same commitment as the remaining owner. This is a complex problem with a simple preventative fix.
The more people involved in a business, the great the risks to manage
Losing a business partner, member or shareholding director can have a major impact on the success of any business. But it’s not just about the loss of profit a business could suffer.
- Could your business continue if one of the owners were to unexpectantly die or suffer a critical illness?
- Who would take their place? Not only in performing their day-to-day duties, but in deciding how their business is run in the future?
The problems of a forced change in business ownership
Imagine if one of your co-owners were to suddenly die. Apart from triggering a technical loan default and a forced call-up of most credit facilities, the next question might be, 'what would happen to their share of the business?'
You could be forced to work with someone new, like one of their family members for example. That person may have no knowledge of your business and no interest in it either. But because they now own a share, they have just as much say as your co-owner had before they died.
Partnership & Multiple Owner Business Risks
Have you considered what might happen if one of the owners of your business becomes critically ill or unexpectedly died?
- They or their family might want to sell their share of the business. This could be to a competitor or some other unsuitable buyer.
- They could force the winding up of the business and put your retirement plans at risk.
- Their family may wish to become involved in the business, which at best could be disruptive or at worst unacceptable to the other owners.
- The remaining owners may have to use funds they intended for other purposes to attempt to buy the shares of the afflicted owner.
The problem of long-term illness in small business
If your co-owner suffers a critical illness this creates even more uncertainty. Will they be able to return to work and if so, when? Will they want to sell their share of the business, and who will buy it? What’s the business plan if they’re off work on long term sickness and opened ended rehabilitation without a fixed return to work date.
By having an ownership protection strategy in place the uncertainty of all of these problems can be avoided.
Ownership protection insurance gives you and your co-owners the security of being able to keep the ownership of the business in the hands of those who have built it. It also ensures an owner who becomes ill, or the family of an owner who dies, receives fair value for their share of the business.
A special note about undocumented Partnership risks
Without a documented Partnership Agreement in place, the surviving business partner(s) could suddenly find themselves in business with the grieving spouse of the late Partner - who may have no business acumen and have very different ideas on the direction for the business.
- Being in business with another person increases the number and type of risks you have to contend with.
- Being in business with two additional people increases the odds that you’ll experience an interruption to your business due to unexpected sickness or injury of one of the business partners.
Remember if you’re in partnership with someone, you are also personally liable for the actions of your business partner, and they, yours.
Documenting Partnership Agreements ahead of time
When businesses are owned by more than one person or entity, the percentage of individual ownership needs to be documented, along with the agreed method of transferring the ownership from one partner to another.
- This usually involves a documented Partnership Agreement – outlining the processes agreed to, and an
- Insurance policy and strategy to fund the agreed payment amount, upon the triggering of the partnership transfer between owners.
All business Partnerships should have a documented Partnership Agreement in place
The often overlooked risk of an undocumented business partnership is the business Partners face an additional ongoing risk of exposure to liability for potential countless wrongdoings of their business co-partners.
Insight Undocumented Partnerships are considered high-risk ventures. This is because undocumented General Partnerships have Unlimited Liabilities
Because a general business partnership is not a legal entity, its partners assume personal liability for all partnership debts and wrongdoings including misappropriation of partnership funds.
- This liability will arise regardless of whether the Partner may have had no involvement in or knowledge of the wrongdoing of the other.
- An unfortunate reality of partnerships is that relationships between the partners may break down over time, which can result in unintended and potentially devastating financial outcomes for the partners as a result of their unlimited liability for partnership debts.
- A frequently occurring example is debts to third parties that go unpaid after a breakdown of the business relationship between the partners.
Those debts remain owing after the dissolution of the partnership, and in some cases may accrue significant interest and penalties. If the debt remains unpaid, Court proceedings may be commenced against one or more of the partners personally.
How to transfer the share of a Business or Partnership, when needed
There are three main ways business Directors or Partners can fund the transfer of a share of a business or partnership.
Option 1 – Self-insure and simply pay cash when this event occurs to buy out the surviving partner.
With this option, the surviving owners use cash at the death of a co-owner to fund the buy-sell agreement.
But there are several drawbacks to this self-insurance approach.
- At the time of the death, funds may not be available for payment.
- A personal Savings Plan can accumulate funds over time, but what happens if the funds are needed earlier than planned?
- Will a savings plan be depleted if there are unforeseen circumstances and the business needs a cash injection?
- Accumulation of cash may cause an accumulated earnings tax problem.
- Accumulating large amounts of unused cash within a partnership exposes those funds to Bankruptcy Trustees and Family Law Court claims.
Option 2 – Wait and try and borrow the funds to complete the ownership transfer when needed.
With this option, the surviving owner attempts to borrow funds, usually from a bank, at the death of their Business Co-partner to fund the Buy-and-Sell Agreement.
- This wait-and-see approach also has high risks
You cannot guarantee that the surviving owner will be eligible for finance at a future date (especially upon the sudden death of a business partner). The death of an owner usually causes disruptions to a business that results in a decline in sales that further complicates asking a bank for money with a decreasing cash flow).
- The death of an owner may remove underlying security assets that may have been used by a bank securing earlier funding.
- The surviving partner may now find themselves having to sign for funds, now exposing personal assets that up to now, have not been required with multiple business partners.
- Surviving Business Partners pay dollar-for-dollar plus interest on any new loans required to fund the ownership transfer agreement, buying out the deceased outstanding share of the business in this interest which will impact the valuation of the business remaining.
- The surviving partner may have to borrow money from the deceased business Partner's family to complete the transaction, effectively putting them ‘in business’ with another who may not have patience and share a similar approach to running a business.
Option 3 – Use a Life Insurance policy to provide the funding needed at the time required.
Purchasing a life insurance policy is usually a cost-effective funding option, to complete a buy-and-sell agreement in the future.
- A Total & Permanent Disability (TPD) policy will also extend the Buy-and-Sell Agreements capacity, in case one of the owners is disabled and can no longer work in the partnerships, but continues to live.
Typically, the policy is taken out on the life of each Business Partnership Owner so that when one owner dies or becomes disabled, the surviving partner will now have money provided by the policy to buy out the family of the deceased (or disabled) partner exiting the business.
Using life insurance as a funding mechanism provides the following benefits.
- Immediately available upon the death of a business partner. the death benefit proceeds are usually income tax-free.
- The premiums of such a policy are usually lower than the cost of repaying loan interest for the same amount would be.
- The cost of the insurance policy is mere pennies to the amount of the payout to the family.
- Having such a life insurance policy in place allows partners to sleep better and work undistracted, allowing them to put their full attention to growing a business rather than wondering what will happen to their share of the business upon the unexpected death or disability of their Business Partner.
Whichever option works best for you, it helps to get all the facts together before you make your decision.
Getting your documented Partnership Agreement in place and then getting your documented Buy-and-Sell Agreement in place, with the right funding strategy, significantly reduces the risks to all business partners and usually results in an uptick in business focus, confidence, and clarity.
Where to from here?
When beginning your thinking about Business Ownership Protection, here are some conversation starters:
The two difficult questions you'll be forced to answer:
- What would happen if your business partners passed away in a motor vehicle accident?
- Would their share of your business pass directly to their spouse or child or estate?
Frequently Asked Questions about Business Ownership Insurance
What happens if my business partner dies and I need to pay out their family and estate for the partner's share of the business?
In an undocumented partnership, when a business Partner dies, their share of the business profit and debt becomes the responsibility of the surviving business Partner.
The family of the recently deceased Partner will usually then seek to sell off the business assets and liquidate the business to extract its value. Without a prior written Business Partnership Agreement in place, there will be no instructions to follow at this very stressful time of business interruption - for the remaining partners and the grieving family of the deceased partner.
How do business partners prepare for this eventuality?
- Get a legally documented Partnership Agreement in place that outlines the agreed liabilities of each partner and the ownership of the partnership's assets. It can answer difficult questions and set expectations ahead of time like:
If one business partner suffers a stroke and can no longer work, do they have the right to continue to draw an income from the partnership for the rest of their life?
If one business partner receives a cancer diagnosis and requires treatment for a yet undetermined period of time and cannot work, do they have the right to continue to draw a full income (or partial income) from the partnership business, and for how long?
If one business partner died, what is their family's interest in the business, and what happens to the business profits, debts, and assets used to secure the debt liabilities?
- Get a legally documented Buy-and-Sell Agreement in place that creates the automatic procedures to be followed upon the death (and/or disability) of a business Partner and the agreed ownership transfer, the sale price to be paid by the surviving partner, and debt arrangements to follow.
- Set up the funding arrangements required to achieve the ownership purchase and transfer from the deceased partner's estate, and debt payout.
How we can help
Business Ownership Protection insurance strategies are an important part of protecting your business and your family, from the business. Sapience can provide legally drafted Partnership Agreements along with Life and Disability insurances and strategies to complete your Ownership continuation planning.
Contact us for a confidential chat about your needs.
Related: Types of Business Insurance products we work with
There are lots of different types of risk protection insurance that can help in different situations.
- Protecting Fixed Business Expenses - those recurring cost-to-stay-open-for-business expenses
- Protecting Business Key Revenue Makers - those Key People in the business
- Protecting Business Debts - the ability to continue to pay debt during recovery from a serious illness or injury
- Protecting Business Ownership - the ability to pay debt determines who ultimately owns the business
- Shareholder and Capital Protection - protecting all Investors in the business, great and small
Are you protecting your business's key revenue makers?
It’s a well-known fact that, as an employer, your most valuable assets walk out the door every night. Many small businesses often rely upon the skills and knowledge of just one or more Key People for generating the bulk of their revenue. These are usually known as Key Revenue Makers or Key Persons in the business.
This means a sudden sickness or illness, a disability or even an unexpected death of a Key Person could cripple a business until they find and train a suitable replacement.
- Many small and medium (SME) business owners are also the Key People in their businesses.
- If they were unable to work in the event of illness or injury, a replacement employee is often required, at least in the short term.
What is Key Person insurance?
Key Person insurance helps safeguard a business against the financial impact of the loss of a key individual – of your most integral employees – who are unable to work due to a sickness or injury or a critical or terminal illness or has unexpectedly passed away during the length of a policy.
Key Person insurances refers to the package of insurance products and strategies designed to protect a business in the event of the loss of a key person who makes a significant contribution towards the profitability of the business.
Broadly speaking, there are two types of Key Person Insurance - Income Replacement and Value Replacement
- Key Person Replacement (KPR) provides a short term solution to a help a business fund the cost of a replacement where the business owner is a key person in their business, and a replacement is required if they are unable to perform their duties during disablement. It can reimburse up to 75% of the direct remuneration costs associated with a replacement employee or locum (for up to a maximum of the insured monthly benefit) while the life insured is unable to work due to sickness or injury and is totally or partially disabled.
- For the high-quality covers, any income generated by the locum or replacement employee does not offset the insured benefit payable.
- Key Person Value (KPV) insurance can compensate a business for direct remuneration costs if their Key Person were to suffer a critical illness or unexpectedly pass away.
- Direct remuneration costs include salary, wages, packaged fringe benefits, regular bonuses, regular overtime payments, pre-tax superannuation contributions and payroll tax.
Key persons do not exist in all business circumstances
Not every business or business structure has a Key Person. For instance, a sole trader can never insure themself as a key person because the business would cease upon their death or total disability. In such circumstances, fixed business expenses cover may be considered.
Your Sapience Financial adviser can help create a suitable strategy to meet your individual business needs.
Designed for the business and its stakeholders
It's about giving your business stakeholders, the owners, the staff, and their families, the confidence that your business can survive and thrive even in the event of losing a key person through death or a specified critical illness.
Key Person replacement insurance cover provides a short-term solution to help the business fund the cost of replacing an employee.
- Key Person Insurance can protect businesses from the financial dips that can occur if there's an unexpected loss of an owner, manager, partner or skilled employee.
- Participation in some critical supply chains may require a business to supply a capacity statement that identified Key People and may stipulate that Key People to a business are appropriately insured against the costs of sickness, injury or death, to the business too
- Participation in a business Partnership or Shareholder funding may require a business to hold appropriate Key Person insurance cover.
Insuring your business's Key Person can provide funds to offset a reduction in the business cash flow that may occur due to an unplanned absence from a serious sickness or injury and may even provide funds to source a locum or find and train a replacement.
Most small businesses haven't considered enough their vulnerability to their reliance upon a Key Person and have no backup plan for the loss of that Key Person.
What's the difference between Life insurance and Key Person insurance?
The difference between Life Insurance and Key Person Insurance is simply the ownership structure of the policy.
- Traditional life insurance protects the family of a person who takes out an insurance policy.
- Key Person insurance is paid for by a company as a business expense to protect its ability to replace and cover the loss in revenue an absent person would otherwise have provided, and as such any claims benefits are paid to the business that took out the policy.
Simply put, Key Person Insurance pays a benefit to the business, rather than the insured person or their family.
Who are the Key People?
Anyone whose unexpected absence would leave a major void in the company day to day operations.
- Specialist skills: a business in the formative stage may heavily rely on the skills and abilities of one or a few individuals, such as a restaurant head chef, medical practitioner, practice manager or sole accountant.
- Operations: a business considering major changes or merges may be more vulnerable to the loss of specialist skills particularly those for which the business depends for the change or merger.
- Resources: a smaller business may depend upon a small group of people sharing their individual skills and pooling their network of expertise to form a partnership.
- Brand: The business founder or head who is closely linked to the brand's image of the business and success in the minds of the general public, suppliers, distributors, customers and other stakeholders.
Or to put it another way, what responsibility might a key person have?
Anyone who is a business owner (or an arms-length employee) with specific skills or knowledge who is working in the business to generate revenue and whose absence from the business would result in significant loss of revenue as the business continued to operate, can be a Key Person and Key Revenue Maker to a business.
Examples of Key Person insurance at work
Key Person Insurance | Shannon's Story
Shannon was a CEO and founder of a specialist company that attracted a particular type of tech investor. His larger-than-life personality and technical insights meant his profile within that industry was strong and responsible for his company's growth success.
While he was the primary shareholder in the business, he had 3 investors who each invested $300,000 to fund the growth strategy. The shareholder agreement specified the business would be required to hold Keyperson style insurance to cover the shareholder's investment upon the death or disability of the founder CEO.
In addition to the investment of $900,000 the cost to replace the founder (in the event of his becoming absent from the business) was $295,000 made up of international recruitment fees, salary costs, and the cost of a year's fixed overhead runnings costs for the business. As part of a protection strategy, the following policies were put in place.
- Keyperson Life insurance $900,000 + $295,000
- Disability insurance $900,000 + $295,000
A year later after coming back from a month's Skiing trip to Japan, Shannon tripped while walking down the fire exit stairs at the company office and broke both his wrists in the process. Thankfully he didn't lose his life or his company, just some dignity.
The Key Person insurance stabilised its income during this period until he returned to work at full capacity.
How we can help
Key Person and Key Revenue Maker Insurance is an important part of protecting your business and your family, from the business.
Contact us for a confidential chat about your needs.
Related: Types of Business Insurance products we work with
There are lots of different types of risk protection insurance that can help in different situations.
- Protecting Fixed Business Expenses - those recurring cost-to-stay-open-for-business expenses
- Protecting Business Key Revenue Makers - those Key People in the business
- Protecting Business Debts - the ability to continue to pay debt during recovery from a serious illness or injury
- Protecting Business Ownership - the ability to pay debt determines who ultimately owns the business
- Shareholder and Capital Protection - protecting all Investors in the business, great and small
Protecting business debts – and the assets used to secure business debts
At some point, most businesses will borrow money from a financial institution or a company director, or both. This might be to provide the business with a capital injection for a major purchase or expansion or simply a source of working capital. These loans are usually secured by a first or second mortgage over the personal assets of the Director and their family, such as the family home and/or business assets.
Whether that security asset is the family home, the actual business premises itself, machinery, or other large plant equipment, there are clear issues to consider by using insurance to clear these loans, in the event of an unexpected death, disability, or serious accident or illness.
What Business Debt insurance does
A Business Debt Protection strategy is designed to help remove (or substantially pay down) business loans in the event a business owner passes away or suffers a serious disability. It's a risk that every business regardless of size, must protect against.
- Insuring your debts is a lot like insuring your working assets – in accountants' speak – business debts are considered assets – you need to protect the assets that drive the profit and revenue.
When taking out business loans and credit facilities, businesses need to consider what would happen if a business principal (ie: the Director) were to unexpectedly suffer from one of the statistical realities of Life and Business, and suffer an insurable event such a serious illness or accident, become disabled and unable to work or even unexpectedly die?
Protect the Business Debt Guarantor
Insurance can be used to protect the assets better used to guarantee the business debts, in case the principal becomes totally and Permanently disabled, suffers a critical illness, becomes terminally ill, or even passes away.
- Secured Loans, from a lending institution are usually secured by personal assets owned by the business Principal. If the owner of that security departs the business their ongoing guarantee of the business debt will end and the debt can be called up for immediate repayment.
- Unsecured Loans, are usually provided personally by a business owner or partner (and usually recorded in a directors loan account entry by the bookkeeper) while unsecured still have to be paid out if that business owner or partner departs the business.
Business Debt Insurance protects the guarantor/owner of the debts in the event of an insurable event.
A cost effective solution to a significant problem
A cost-effective way to provide an injection of cash to address these risks is for the principals to take out sufficient Life insurance, Total & Permanent Disability (TPD), and Critical Illness\Trauma insurance.
Without a business debt insurance strategy in place, if any of these events occurred, the business could have difficulty meeting its loan commitments.
- Usually, the death or disability of a Director is considered a contractual trigger event for an automatic call-up of any outstanding loans for repayment immediately
- The lending institution could have concerns about the business's cash flow and credit position and may require the outstanding loan to be repaired immediately.
- The lenders may then move to first seize the assets used as security for the debt, and then move to seek a mortgagee in possession order and fire sale assets so the debts can be cleared.
Important to Understand The death, disability or serious illness of a Director (who acts as a guarantor to the loan) may automatically trigger a contractual loan 'call-up' with the debts having to be paid upon demand and cripple the cash flow of an unprepared business.
How does this help you?
The funder will always deal with a business in a commercial manner.
- This means you can expect them to consider you have your own business debt insurance policies in place.
- Your family would probably expect you would have a backup plan in place too.
- Your accountant or business advisor would expect you have a Loan to Business Agreement in place as well to put it beyond doubt, that any loans to the company were in fact at call loans, and not to be considered an equity injection by the owner.
If your business has business debts secured by personal or business assets, you need to get business debt insurance in place.
Three types of business debt insurance
Business owners can protect themselves from insurable events occurring.
- Life Insurance can play an important role in clearing business debts in the event of the principal's death or terminal illness.
- Total & Permanent Disability (TPD) insurance pays out upon a long-term disability and usually has a 6-month waiting period.
- Crisis\Trauma (CI) Insurances pay out immediately in the event of a specified serious illness occurring.
Insight: A common misconception is that Crisis\Trauma (CI) Insurance and Total & Permanent Disability (TPD) Insurance are interchangeable and payout on identical conditions. This is not the case for all clients and won't apply in all situations.
For example; a principal may suffer a heart attack and return to work several months later. In this case, a CI not a TPD claim may be paid. Conversely, if a principal suffered a nervous breakdown, they might not be covered for this under a CI-specific list of health conditions but may be able to claim under TPD as a general 'inability to continue to work' due to that condition.
Depending on a client's individual circumstances, taking out insurance to cover all three insurable trigger events (death & terminal illness, TPD and CI) may be appropriate.
Case study
Business Debt Insurance | Raj's Story
Most businesses owe their Directors money.
This was the case for Raj who started his family-run wholesale food distribution business 6 years ago from his home garage. Rather than take a full wage, he decided to leave most of the profits in the company as 'Owners Funds' (money lent to the company by the director to help grow the business and lower the costs of running a bank overdraft account).
- Over the years Raj's accountant calculated the company debt to the company Director was $500,000.
One day Raj wants to take those funds out of the business but until then, to protect himself and his family, Raj’s company took out two types of life insurance policies naming Raj as its beneficiary, each for $500,000 to cover the outstanding balance owing to Raj and his family.
- Life insurance & linked Permanent Disability Insurance $500,000 - paying out if Raj were to pass away unexpectedly or suffer a terminal illness.
- Medical Crisis insurance for $500,000 - paying out if Raj were to suffer a listed medical crisis event and be unable to continue to work.
Having Business Debt insurance in place has brought certainty to him and his family that the business he worked so hard to establish will be able to meet its business debt responsibilities to its Director and his family, just in case life and business do not continue as planned.
How is the level of Business Debt insurance calculated?
Two approaches are used to calculate the sums insured required; debt cancelation and proportionality.
1. Debt Cancellation Method
The Debt Cancellation method involves calculating the cost of canceling the entire debt so that all guarantees or assets used as debt security can be released.
The basis for this method is the business principles are each jointly liable for the entire business debt and it may be appropriate where there are only a small number of principals (eg; two or three) and each of them plays a crucial and distinct key person role in the business.
In this scenario, the death, disability or serious illness of one of these principals is likely to have a significant impact on the business's ability to meet its loan commitments. Therefore, there is a high risk that the remaining principals could lose (or be forced to sell) any personal or business Assets used as loan security
Pro Tip: The debt cancellation method may not be suitable for businesses where there are several principals as the underwriting rules may determine the key person effect is not equally born between a large number of principals.
2. Proportionate method
The Proportion Method calculates the percentage (or degree) each business principal has in a particular debt, and then insures each principal for that specific amount. The basis for this method is that business principals are joint and severally liable for the business debt.
Having the right debt insurance in place means that you’ll have the funds to reduce or repay any business debt (and importantly safeguard any funds the business owns you as a director or shareholder) and protect your personal assets from being seized to pay business debts, should one of the insurance events take place.
Pro Tip: You should be aware the proportionality of debt obligation is not automatically always aligned with their equality share in the business or interest in the debt. For example; the principal who has provided the highest amount of security assets securing the debt might have the highest proportion of insurance taken out on their life.
Special Note: Milestone Fixed Term Life policies for Business Owners & Special Use
Need protection for a set period of time only or want to lock in premiums for 5, 10 or 15 years
Sometimes people need a life insurance or disability policy for a fixed period of time; whether that's to protect a fixed-term debt, safeguard the run-up to a business sale, or even a retirement, a Milestone Strategy can be useful. Often referred to as 'Term Level Policies', these strategies have Business and Personal applications that can help you better match the right premium pattern to your needs.
Business Short-Term Needs
Business succession - for pre-retiree.
Business loan on equipment.
Key Person with short term need.
Business Medium-Term Needs
Business succession - partner to retire in 10 years.
Business protecting debts secured by family home.
Key Person with needs of up to 10 years.
Business Long-Term Needs
Business succession - a younger business owner.
Key Person with long term need.
Buy & Sell strategy with stabilised premiums.
What happens at the end of the fixed term?
You can continue with the cover after the initial term expires on variable premiums with no additional underwriting required.
How we can help
Business Debt Protection insurance strategies are an important part of protecting your business and your family, from the business.
Contact us for a confidential chat about your needs.
Related: Types of Business Insurance products we work with
There are lots of different types of risk protection insurance that can help in different situations.
- Protecting Fixed Business Expenses - those recurring cost-to-stay-open-for-business expenses
- Protecting Business Key Revenue Makers - those Key People in the business
- Protecting Business Debts - the ability to continue to pay debt during recovery from a serious illness or injury
- Protecting Business Ownership - the ability to pay debt determines who ultimately owns the business
- Shareholder and Capital Protection - protecting all Investors in the business, great and small
Protecting the long term Value of your Business can feel like a moving target
Two often ignored and inconvenient truths for a business owner are:
- One day in the future we will all leave our businesses - either planned or unplanned, and
- If you have a business partner - you need a Buy & Sell Strategy agreement.
While there are many ways to plan for a future transfer of ownership rights to a business, the reality is we can all be unexpectedly forced out of our business due to a sudden change in our health: a disability, a significant illness like cancer or a heart attack or even an unexpected death. This is where a Buy and Sell Strategy comes into plan.
Introducing the Buy & Sell Strategy
A Buy & Sell Strategy is a combination of legal documents and life insurance and disability policies, all working together to provide certainty about what happens to the business when one of the owners or partners is suddenly forced to leave – because of an unexpected disability, serious medical illness or even an unexpected death.
- For the remaining owners: a Buy & Sell Strategy means the remaining owners can quickly buyout the departing owners share of the business and continue to run the business with minimal disruption.
- For the departing owners (and their family): it also means the owners family (or their estate) are fairly compensated for selling their share of the business to the remaining business partner.
Quick Summary
While there are a number of different structures available for a Buy & Sell Strategy, insurance self-ownership is the most common.
Under the self-ownership option, each person owns an insurance policy on their own life. If a business owner exits the business due to death, disability or significant medical trauma, the following sequence of events will then generally occur:
- First: the insurance payout is paid to the departing owner (or their estate)
- Second: the departing owner then (or their estate or beneficiaries) accepts the insurance payout as full payment for the departing owner’s share in the business, and
- Third: the departing owner’s business interest is now fully transferred to the remaining business owners.
There are a few different ways to structure a Buy & Sell strategy, and your accountant can advise you, but ultimately it means the surviving business owner or partner has 'first rights to the purchase', even if the owner dies and their ownership transfers to his or her estate.
Alternatives to using a Life & Disability Insurance to provide the funding for a forced buyout of a business partner?
Option 1: Wait and pay cash for the business – if you have it
With this option, the surviving owner(s) use cash at the death or disability of a co-owner to fund the buy-sell agreement.
This can create additional problems
- What is the plan if a forced exit occurs tomorrow before you have time to save up funds for this event?
- At the time of the death or disability, funds may not be readily available for payment.
- A long term savings plan accumulates funds over time and attracts taxation obligations.
Option 2: Wait and try and borrow funds to buy the business – if you can
With this option, the surviving owner(s) borrow funds, usually from a bank, at the death of a co-owner to fund the buy-sell agreement.
This can create additional problems
- The death of an owner may cause sales to decline, and if their property secures a business overdraft, this is automatically called up upon the death of a loan guarantor.
- A surviving owner may have to personally guarantee ongoing trading debts therefore exposing personal assets.
Option 3: Use a Life insurance policy – for immediate funding of a forced sale
Purchasing Life & Disability insurance is usually the most cost effective solution for funding option for a buy-sell agreement. Typically, a policy is taken out on the life of each owner so that when one owner dies, the surviving partners now have money to buy out the family of the deceased partner.
Using insurance as a funding vehicle will provide the following benefits:
- Immediate availability of funds when the death occurs
- The death benefit proceeds are generally tax free
- Insurance premiums may be lower compared to the cost of repaying the loan interest
Where to now?
A few questions to ask yourself before your business partner dies or suffere a disability:
- If my partner suddenly dies or has a heart attack, what would happen to the business?
- How would this affect my family and the family of my business partner?
- Is it possible you and the surviving parties will have conflicting ideas about how then business should be run in the future?
- Will suppliers and creditors continue to extend you the same trading terms?
- Will customers maintain their confidence in your products and services?
- Will important employees suddenly begin to leave if their future looks uncertain?
- Can your business partnership continue after the death or disability of an owner?
Worst case scenarios - more frightening than you think
If you don't see the importance of having a Buy & Sell Strategy in place for yoir business, here are some common scenarios you should be prepared to face, should you find one of the business partners is forced to exit
- Liquidate the business and distribute the remaining assets
Considering the amount of time and money you have invested, as well as the sudden loss of steady income - this may be your least favourite choice. Depending upon the future state of the economy, you most likely may be forced to sell your business and its assets for a lot less than they’re worth. - Take on your late partner’s heirs as your new business associates
Most grieving spouses and heirs will see the business as a liability to sell off, or a cash-cow to drain. You should also expect their level of business experience will not match that of your late business partner. - Sell your share of the business to the heirs
If you don’t have a business valuation agreement in place (this is part of a Buy & Sell Strategy) you should prepare for heartbreaking problems with the heirs that you never would have had with your business partner. - Buy out the heirs’ share of the business
This is often the most practical choice and the most expensive choice. This is where having a Buy & Sell Strategy in place can help.
How we can help
A Business Value Protection Strategy is an important part of protecting your business and your family, from your business. Sapience can work with your Accountant and Lawyer to provide the insurance based funding mechanism for your Buy & Sell Strategy.
Contact us for a confidential chat about your needs.
Related: Types of Business Insurance products we work with
There are lots of different types of risk protection insurance that can help in different situations.
- Protecting Fixed Business Expenses - those recurring cost-to-stay-open-for-business expenses
- Protecting Business Key Revenue Makers - those Key People in the business
- Protecting Business Debts - the ability to continue to pay debt during recovery from a serious illness or injury
- Protecting Business Ownership - the ability to pay debt determines who ultimately owns the business
- Shareholder and Capital Protection - protecting all Investors in the business, great and small
