Your business is a financial foundation for all the people involved in it, including the families of staff. In that sense, your business is an essential part of the financial plans of many people. This is one of the best arguments for protecting your business from the risks that can affect its viability.
Luckily, simple financial mechanisms are available to secure the future financial plans of the people who depend on the business.
What risks?
It's unnerving thinking about risks, but as a business person, you know that thinking ahead is necessary. With that principle in mind, what would happen to your business if you or a business partner were forced to withdraw from the running of the business entirely?
Such a situation could occur if a medical trauma such as an illness or injury left you or a business partner permanently incapacitated, or if you or a business partner unexpectedly died.
This is a fundamental issue that faces any business, and depending on your circumstances, there may be serious repercussions.
Debts
Your business may have debts. If you or a business partner suddenly dies, could the business afford to continue to pay those debts if a key person is no longer generating revenue?
In this scenario, it would help if you had transferred the debt risk by having the debt insured. That means if you or a business partner become incapacitated, a lump sum can be paid by the insurance company to clear those debts and the remaining partner can run the business unencumbered by financial burden.
Buy / sell agreements
If you are in a partnership arrangement, what happens to the ownership of the business if you or a business partner dies?
One scenario sees you continue to run the business in conjunction with the deceased partner's spouse, who would effectively become a part owner. But would this be a desirable situation for all concerned?
Another possibility is for the remaining partner to use a lump sum to buy out the other share of the business. In this event, will that lump sum come from a loan? If so, can the business or the parties borrowing afford that loan?
With insurance, the money paid out in the event of the death or disablement could be used to buy out the other partner's share, leaving 100% ownership with one person.
Key person insurance
Another important issue is the effect that the loss of a ‘key person' will have on the future operation of the business. A ‘key person' is someone who generates a significant portion of the business' revenue or who has a critical role to play.
In this situation, you might be in a better position to adjust to the necessary changes if you had transferred the risk to an insurance company, by insuring against the loss of the key person.
An insurance payout in this situation would provide a lump sum injection into the business that may be used to source a new person to bring the business back into operation.
Business continuity
Another area that needs to be considered by businesses when taking out insurance is "business continuity". This means that the shareholders' agreement takes into consideration all situations that may arise that need insuring through a buy / sell agreement such as "default" events.
A default event could be insolvency, good-leaver / bad-leaver and incapacity. Many businesses would be insured for an event such as death, but many wouldn't be insured to cover a default event, so it is imperative to make sure the shareholders agreement covers all possibilities.
Estate planning
Proper estate planning is important in a business to ensure your commercial assets are distributed to your beneficiaries the way you want them to be, when you die.
For example, if not all members of your family are interested in being involved in the business, but you want to ensure an equal distribution of assets when you die, you need to take steps to ensure this.
Estate equalisation ensures that if something were to happen to you, your business can remain intact for those that want to be involved, while those not wanting to be involved can receive an equal value in the form of a life insurance policy.
What's the best way to prepare?
It's better to consider all these issues as a whole, and put in place a plan that knits a series of specific solutions together into one strategy.
For example, your strategy may include covering debts and expenses, having a succession plan to pay out surviving partners for their share of the business and key person insurance to ensure it keeps running. There's also the finalisation factor if you have a business of value and want to pass that on to the next generation.
Then there are structures to put in place to maximise tax benefits. Depending on the structures already in place, some premiums are deductible and some are not. However, there are ways to structure your policy so tax is minimised. It's particularly important to ensure that ownership structures and premium payments are approached correctly to avoid any capital gains tax.
A demonstration of the various issues at play
Most businesses will have some sort of Key Man insurance which will take effect should a business partner pass away. The company that owns the policy will receive a benefit that will cover the whole value of the deceased partner's share of the business, or part of it, with the rest covered by the surviving partner.
What many businesses don't consider is the Capital Gains Tax (CGT) that would be payable by the estate once the funds have been received.
One possibility to reduce the CGT component is a "Contract to Will": The partners contract to will over their share of the business to the value of the insurance policy.
By implementing this strategy, the deceased's estate doesn't pay CGT on the policy payout and the living partner doesn't have to pay out the estate, but retains the business. (It is worth noting that with this strategy the partners would have to review the life policies annually to make sure they are keeping up with the value of the business).
This example demonstrates that by considering the various issues together, rather than in isolation, a more complete insurance strategy can be devised.
What insurances can be used?
Many people are familiar with personal insurances such as life, income, trauma, total and permanent disability, and business expenses insurance, which can be purchased to provide financial protection for individuals from common risks, such as injury, illness or death.
However, what's less commonly understood is that these same personal insurances can also be used to protect your business, if set up in the right way.
What should you do next?
Seeing your accountant and financial adviser is an excellent next step.
These are complex issues and you need to consider a number of different elements based on your business structure and the needs of the individuals concerned.
There are also some basic traps you can and should avoid.
A financial adviser can help you determine the type and level of insurance as well as the insurance structure that best fits your circumstances.