Insurance and succession planning for small businesses

10 March, 2020

When you start out in business, your focus is likely to be on growth and managing day-to-day activities. Then, as your business expands, things get more complex.

Perhaps you take on more employees, acquire more assets or develop your product and service offering. As a business owner it’s important to protect yourself and ensure the financial wellbeing of your family and your employees. Here are three important insurances you should consider to protect your business.

1. Business insurance

No matter how small or large your business is, or how it’s structured, it will likely face a number of risks. These risks could relate to the economy, competition or changing consumer behaviour and can be hard to control. One risk you can control is people risk -  that is, the financial impact to your business if a key person dies, becomes disabled or suffers from a severe medical condition.

Types of insurances to control people risk are:

Key person insurance

Your business may have significant assets in real estate, equipment and inventory, however, the biggest assets are often people who are integral to its operation. An over-reliance on key personnel represents a significant risk to your business. The loss of these key people in terms of skills, knowledge and ideas could have a huge impact on the survival, profitability, and growth of your business. Even if your business survived initially, finding a suitable replacement for a key person may take a considerable time.

Key person insurance is a form of life insurance for an employee whose loss would have a significant impact on business profitability and continuity.

Key people could include:

  • managing directors
  • financial controllers
  • sales executives and managers.

Buy/sell agreements and life insurance

Generally, a buy/sell agreement is made up of a transfer agreement and a funding agreement.

The transfer agreement relates to the transfer of the departing owner’s interest in the business to the surviving owners if a trigger event happens — commonly death, disability or a traumatic health event.

The funding agreement relates to how the departing owner, or their estate, will be compensated for surrendering their interest in the business. Life insurance policies are a common way to fund a buy/sell agreement on the death of an owner. In the event of a death of a co-owner, the other co-owners will be paid a lump-sum that is then paid to the deceased’s surviving family members to acquire the deceased co-owner’s share of the business. There are many ways these policies can be owned and structured.

Business expenses insurance

This type of insurance is similar to income protection insurance. The main difference is that while income protection covers you for loss of income, business expenses insurance pays for fixed business expenses if you can’t work and pay those expenses due to illness or injury. This includes expenses for rent, utility bills, employee salaries and other fixed expenses.

2. Business succession plan

As a business owner, it’s important to develop a comprehensive succession plan for your business detailing exit strategies in the event of your, or another owner’s, departure due to retirement, ill health or death. Without a robust succession plan, a business may fail, resulting in the potential loss of income for the remaining owners.

Benefits of a well-structured succession plan

  • Reduces delays and assures continuity of the business with minimal disruption.
  • Eliminates claims to management rights of the business by the estate of the departing owners in the event of a death.
  • Protects against the business being ‘frozen’ due to probate difficulties or legal restrictions if an owner loses legal mental capacity.
  • Provides assurance to co-owners of the business that they can afford to buy the shares of a departing co-owner should they decide to leave the business for any reason.
  • Ensures an agreed and fair price for the departing owner.

Developing a succession plan involves selecting successors, identifying long-term business objectives, consideration of tax structures and outlining the process for a smooth transition to ensure business continuity.

3. Estate planning

There are unique challenges when it comes to estate planning for businesses. One of these is estate equalisation, or ensuring the assets left to beneficiaries are valued evenly when distributed.

Often beneficiaries are not interested in continuing the family business and assets or property (such as a farm) are not easy to divide and convert to cash. There are also often tax implications when selling assets, such as capital gains tax. An equalisation clause in your Will can be useful in these situations to ensure each beneficiary inherits the same amount in the most tax-effective manner.

If you’re a sole trader, you can nominate a ‘caretaker’ who will look after the business during your absence or who can arrange to sell the business if you’re unable to do so.

If your business is structured as a company or trust, a buy/sell agreement together with appropriate insurance allows you to buy an outgoing partner’s share of the business and give you the necessary control to ensure this occurs.

If you’re a business owner and are interested in protecting your interests, please contact us.