Business Insurance - Who Needs It?
15 Jul 2014
Like many of us, small business owners can tend to avoid facing up to their own mortality and dealing with some of the risks inherent in life.
Understandably, people like to think that their business will continue forever with themselves at the helm. The reality however, is that death, disablement and illness often force many men and women from their roles within a business.
Take the classic case of two brothers, Johnny and Ross, who operated a business together in the basic format of a partnership. They got along well, had the occasional fight, but were generally joined at the hip. The business was going well and their incomes covered their lifestyles and provided for their respective families.
When Ross was diagnosed with testicular cancer, he was forced to take time off work for treatment. Johnny had to employ someone to cover for Ross. Whilst this was a drain on the partnership profits, they were left with no other option.
After six months, Ross' condition deteriorated and he passed away aged 49, leaving a wife and two young children. Johnny, now running the business by himself, had to retain the new employee to keep the business going and paid what profits were left to Ross' family as they were struggling financially. Unfortunately resentment quickly built and family relations were strained. Ross' wife felt she deserved something out of the business that her husband devoted his life to, but Johnny felt pressured and tired of providing for two families.
Unfortunately, stories like this are far too common and as an adviser I often hear the sad story at the end and without getting the opportunity to stop this scenario from eventuating.
What could have been done to avoid this?
The negative financial outcome of this situation could have been avoided if Ross and Johnny had engaged an insurance adviser and solicitor for some useful advice.
Firstly, Johnny and Ross could have entered into a buy/sell agreement that dictates the terms in which the business will transfer from one owner to another. For instance, the agreement could have stipulated that in the event of death, disablement or critical illness of either party, the business would be transferred to the other owner for a specified amount based on a specified formula (of profit) or business valuation. This document would be drafted by a solicitor and all parties would sign off to ensure that the agreement was legally binding.
The buy/sell agreement could then be funded by insurance policies. Each partner could have obtained life, disablement and trauma insurance cover for a specified amount. The policies could be simply owned by themselves and the business could even pay the premiums so as to ensure both owners maintained their policies. Ideally, the buy/sell agreement would refer to the insurance policies as a method of funding the business sale from one partner to the other.
If they had taken this approach, Ross would have received a payout from his cancer diagnosis via his trauma or critical illness policy. This would have assisted his family with funds for medical costs and time off work without financial stress.
When Ross passed away, his nominated beneficiary or estate would have received the funds from the life insurance policy as consideration for the sale of the business to Johnny. These funds could be used to retire debt or pay for school fees and would have helped ease the financial burden for Ross' family.
Johnny, whilst receiving no funds from the insurance, under the terms of the buy/sell agreement would inherit Ross' interest in the business. Johnny would be free from the financial burden of having to assist Ross' family and could continue managing the business without the awkwardness of having other individuals come into the business on Ross' behalf.
As an adviser, nothing would please me more than to see this outcome, as the financial issues would have been dealt with and the families could then focus on the important issues and emotions involved with losing a loved one and trying to rebuild their lives.
Sadly, the statistics indicate that far too many Australian's are underinsured and small business owners often run the greatest risk when it comes to death and illness.
I encourage all people, particularly those with young families, large debts and/or small business interests to engage with a professional financial adviser to assist you in developing a plan to cover for the worst case scenario. While we all hope to sail through life without any bumps along the way unfortunately, for many, life just doesn't turn out like that. So the best advice I can give is make sure you act now to protect yourself and your loved ones and be prepared for whatever life brings your way.
To learn more about Philip, view his online profile.