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
