Basic Rules for Protecting a Business

Basic Rules for

Protecting a Business

Don’t know where to start?
Here are some basic guidelines to follow when looking to protect your small business.


Always Protect the Costs-to-Stay-Open-for-Business first

The costs to stay open for business are the 'fixed overhead costs' and are often contractual in nature. Make sure you have 12 months of fixed-cost funding on hand, just in case, so you can have a business to come back to after you recover from an unexpected sickness or accident, or so you can have an active business to sell as an ongoing concern if you have not yet recovered after 12 months. Insuring the Fixed Overhead Costs reduces the risk to a small business.


Always Protect the Key Revenue Maker

The biggest risk to a small business is usually its overreliance on its Owner. Whether the Business Owner, a Specialist Expert or a Key Person, most businesses derive the bulk of their revenue from a few key individuals.

Insuring the Key Person to the business protects a business from the financial dips that can occur if there's an unexpected loss of an owner, manager, partner, or skilled employee through sickness, injury or even death.


Always Protect the Business Debts

Businesses use debt to start-up or to grow. Whether these funds are supplied by the owner (Directors Loan Account) an external funder (using 1st mortgage security over property assets) or investors (usually a combination of mortgages and Director Personal Guarantees), nothing stops a business like an unexpected and immediate call-up of debts, well before they're expected to be repaid. Nothing stresses a business and its suppliers as having difficulty meeting its loan and debt obligations. Insuring the Business Debts & Liabilities from sickness, accident, or even death of the Owner, Business Partner or Key Person reduces the risk to a small business.


Always Protect the Business Ownership

Owning a business in Partnership with another means all the Partners need to protect their portion (equity investment) in the business to make sure the future control of the business stays with them. A forced change in ownership, due to one or more of the partners unexpectedly suffering a motor vehicle accident, ill health, or even death and then selling their shares, could destabilise the business ownership and risk its future. Protecting business ownership with a Partnership Agreement, Company Powers of Attorney and Insuring the Business Ownership, help reduce the risk to a small business.


Find a Risk Adviser specialising in working with Small Business Owners and their Families

Protecting yourself and your family from the risk of running a business is key to business and family harmony (and peace of mind). This is because small businesses and the families that support them have different risks, liabilities, and time constraints than average employee-based families. The team at Sapience Financial specialise in working with small business owners and their families, Sole Traders, Partnerships and Multi-owner business, and their Companies to help them protect themselves from their business.

Business Debt AND Ownership Protection Insurance explained

two business partners in casual shirts working together

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 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 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.

  • Multi Owner Businesses are usually company structures where the ownership percentage of the company is clearly determined by the number of shares individually held.
  • Business Partnerships often start out as informal arrangements where individuals work with each other on shared projects.

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.

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