Shareholder and Capital Protection
Who is the owner a business is usually easy to explain; but who are the shareholders (and beneficiaries) in its future value, can be more difficult to identify. The overwhelming majority of small business owners cite a key reason for their working in a small business is for their family's future benefit.
A Shareholder and Capital Protection insurance strategy ensures there are sufficient funds available and documents to confirm a commercial agreement exists, so that if a business Partner or Shareholder were to become disabled, terminally ill or even unexpectantly die;
- there is a pre-agreed and legally documented buy-and-sell arrangement in place, and
- there is an insurance policy in place with sufficient cover to fund the pre-agreed buyout, pay taxes and complete the sale of that share of the business to the surviving owners and or shareholders.
Pro Tip: A personal Critical Illness insurance policy can also be added to the strategy extending the Shareholder Protection strategy to include protection against serious sickness and accidents too.
This agreement between business owners ensures that shareholders maintain the rights and the money (from an insurance payout) to buy the remaining share and retain control of the business.
Who is this for?
While different businesses all have unique strengths and needs, the one common denominator to all of them is they all run on people and capital. Protecting both, is part of a Shareholder and Capital Protection strategy.
- All businesses have an Owner, a Founder, usually a Key Person, and use capital to help it all grow.
- Capital and Shareholder protection strategies are designed to help protect the future value of a shareholder's interest and ownership in a business and protect the invested capital injected into that business as part of its growth strategy.
Protecting Ownership by funding the power to buy out your business partner if needed
Many businesses are owned by more than one individual or entity and it's not long until most businesses begin to 'owe money' to their Directors, and then to external investors and lenders to meet capital needs for expansion and growth.
This introduces a unique multi-owner business risk where if one owner needs to depart the business because of sickness, illness, disability, or unexpected death, this strategy can ensure the remaining owner has the legal rights to buy out and sufficient funds available to purchase a departing owner's (or shareholder's) ownership portion.
But that’s often easier said than done, especially when it comes to capital raising and capital protection, and business debts.
Protecting Capital investment
Using investment borrowing to grow a company can be exhilarating. Over the years we've seen many small to medium (SME) businesses establish themselves and grow successfully in a variety of economic conditions. We've also seen others that stalled for reasons sometimes only recognisable in hindsight.
But as exciting as the new cash flow injection may be, it can be equally threatening. Built into the process of borrowing money from others - either as capital raising investment or capital use borrowing, are certain harsh realities that can seriously damage a business if you are not prepared for them.
- SME’s are usually heavily dependent upon an owner or a Key Person during the early years of the business.
- Businesses need funding and access to capital (sometimes from the start-up and initial development) usually at their first growth inhibitor of around $750k.
Protecting the Owners Loan Account entitlement
An often important consideration that is missed it understanding most business have a Director's Loan Account on the books – accountant speak for, money lent to the business by the owner – that needs to be repaid to the owner or their family upon its sale or the unexpected death or disability of the owner, who lent that money to the business. Just because the owner lent money to the business doesn't mean that it is any less valuable or less worthy of protecting; especially as the business owner and their family are probably relying upon the business to enable them, to retire one day.
- Always make sure your family can get your money back from your business if its Director or Owner dies.
Protecting Capital investments and uncomfortable questions for investors and founders alike
Capital investments need to be protected from the associated statistical people-based-risks every business is exposed to. This means the health of the Founder, Director, Business Partners or Key People is an important determinant for an investor and is often overlooked.
The Investor's questions
Investors normally set the expected rate of return to match the degree of risk an investor is taking — usually referred to as 'rate to risk'.
While 'due diligence' is said to be, 'the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or contract with another party,' the question remains, is the capital investment able to be adequately protected?
More simply put, "Is the company Director or Key Person insurable?"
Is the company Director or Key Person insurable?
What's the effect of a Director, Partner or Key Person in a business not being able to gain personal insurance?
- Does this mean the capital investment cannot be insured?
- Does this affect the credit-worthiness (or the invest-ability) of the small business?
Either way, investors who do not consider and rate the risk accordingly, may be facing a low-risk venture that is actually more a high-risk venture.
Are you investing in a Business, or its People - or both?
There are so many ways to invest in a small to medium (SME) business. Time, provision of expertise or assets, introducing relationships, good ideas and capital investments. The list can appear endless.
The unspoken problem for Capital Investors and Shareholders in a business
You cannot automatically assume that all Directors, Business Partners or Key People are insurable.
Investors are often kept in the dark about such matters and usually, Directors, Business Partners and Key people only learn about their individual health-related conditions when investments are completed and they are only then seeking to set up personal insurance as part of a deed of agreement, to offset the risk.
People, processes and Capital Protection
Small to medium businesses (SME's) are essentially about people and processes.
Because all businesses are built upon and managed by people, they’re all exposed to the same people-based risks. These are the statistical realities of life, we refer to them as The Numbers of Life and The Numbers of Business.
- Statistical risks are ones you cannot avoid, only better manage for possible outcomes.
- Environments (process) risks are managed by good procedures and processes.
Know your statically greatest risk
Knowing which of these risks is statistically working against you is key to insightful investment decisions and protecting capital investments in an SME.
For example:
- What is the risk to invested capital if there are no Life insurance products in use on the lives of the company Director, Founder or Key People - all contributing to the repaying of invested capital?
- Worst still, what's the risk to the capital invested if the Director, Business Partners or Key Person supporting the business, are personally uninsurable?
- Does this aspect need to change the interest rate such investments command, or does it make a capital investment overall less appealing?
Read our article: Prostate cancer surgery and its disturbing new link to business risk about radical prostate surgery and unexpected cognitive decline.
Pro Insights | Shareholders Agreements and the deficiency in the detail
Capital Protection and Shareholders Agreements are designed to protect invested capital from known insurable major risks. These documents typically require insurance to be in place to safeguard against the ‘unexpected death or long-term disability’ of a director (or Keyperson).
For example, if a $500,000 capital investment is made into a new business venture, it's usual for a $500,000 insurance policy to be put in place to protect the shareholders from the capital loss that would result from the unexpected death or extended disability of the director or (key person) in the venture.
- The Keyperson Agreement wording is usually along the lines of; “...death or extended incapacity of the persons referred to in this agreement ...”
The mistake of protecting the lowest risk, while ignoring the highest
But as these agreements are often drafted by lawyers who are not financial advisers, they’re often unfamiliar with the changing data around statistical risks to the business.
The unintended consequence can be drafting a shareholders agreement that only requires protection from the statistically lowest insurable risk events (like unexpected death or long-term disability) and not the insurable high-risk event (a health crisis event) like prostate or breast cancer.
Rating for risk and protecting capital investments
At Sapience Financial, we address the statistically predictable people risks so business owners, management teams and investors alike can reduce their exposure to their people-based risks, and protect their business and its shareholders from the risk to its capital borrowings and investment.
Different businesses all have very different needs and unique strengths but the one common denominator to all of them is they all run on people and capital.
Frequently Asked Questions about Capital and Shareholder Protection
What is a business-secured creditor?
A secured creditor is one that holds a security interest, such as a caveat or a mortgage over some or all of the company’s assets, to secure a debt owed by the company. As lenders usually require security when they provide a loan, the best way for a creditor to secure their interest is by registering it in the Personal Property Securities Register (PPSR), an online register of all personal property that has security interests registered against it.
Likewise, an unsecured creditor is one who does not have a security interest over the company’s assets and whose interests are secondary during a forced debt legal repayment action.
What is a director's guarantee?
A Director Guarantee agreement is a document signed by a company director giving a personal guarantee that the director will be liable for the company's debt or commitment if the company does not meet that obligation. Directors' Guarantees are lower on the hierarchy of debt security behind 1st mortgage' guarantees and registered debt holders.
Who gets paid first when a company is in liquidation?
Company liquidation is a legal process by which a company’s assets are sold, its debts paid as far as possible and the company is closed or deregistered. If the same personal property is used as a guarantee for two or more different debts, priority rules apply.
If the debtor defaults, the rules determine the order of priority in which the various secured parties can enforce their security interests.
Generally:
- a secured creditor has priority over an unsecured creditor
- priority between two secured creditors is determined on a first-in-time basis
- there is no priority between unsecured creditors.
Therefore, the company liquidator will only pay unsecured creditors if there are funds left over after payment of the costs of liquidation and payment to secured creditors and employees. Usually, the order in which funds are distributed after payment of liquidation costs and secured creditors is:
- outstanding employee wages and superannuation, then
- outstanding employee leaves of absence, including annual leave, sick leave (where applicable) and long service leave, then
- employee retrenchment pay, then
- unsecured creditors.
Harsh realities
Each category is paid in full, before the next category is paid.
If there are insufficient funds to pay a creditor category in full, the available funds are paid on a pro-rata basis (and the next creditor category or categories will be paid nothing).
How we can help
Business Shareholder and Capital 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
