Q I own shares in a small business under a company structure. My business partner and I have different skills which are complimentary; my focus is sales and his skills are technical. We have been in business together for 10 years and the business is expanding. We have recently purchased premises and have taken on considerable debt to fund the purchase and expand the business. We both recognise that we need insurance to protect the business and each other. What type of insurance should we consider and how do we determine how much to insure for?
A In these situations, the role of insurance is typically to ensure that the business remains financially viable and the business interests of the shareholders are protected in the event of the Death or incapacity of either business partner. There are 2 critical areas of insurable need that you need to address; insurance to protect the business and insurance to protect the respective shareholder’s interest in the company.
Insurance to protect the business is commonly referred to as Key person Insurance and is typically owned by your company on the life of the key person to be insured. Key person insurance commonly falls into 2 key areas; Insurance to provide capital and insurance to replace income. Insurance for Capital purposes would for example be to provide a lump sum to pay out a business debt. Insurance to replace income would be to provide cash flow for a business to meet operating costs. For example, it could provide cash flow to the business whilst a replacement employee is recruited or a contractor or locum appointed to provide for business continuity whilst a key worker was unable to generate income to the business.
Insurance for shareholders protects the rights and benefits of the shareholders. This type of insurance is commonly referred to as Buy Sell insurance and is typically owned on the individual’s life in their own name. The legal entitlements and obligations of shareholders is encapsulated in a legal agreement referred to as the Buy Sell Agreement. The funding to execute the legal agreement is provided by the insurance contract.
The Buy Sell insurance provides a lump sum benefit and the agreement provides the terms and conditions of the payout to the deceased estate or to the disabled shareholder in exchange for their shares in the business.
The agreement transfers the deceased or disabled business owner’s shares to the surviving business owner and protects their rights to continue the business unimpeded. For example, you may have a great relationship with your business partner’s wife or children but you may not necessarily want them as your business partners beyond your partner’s death or disability!
You and your business partner need to agree on the value of the business you are prepared to accept in exchange for your shares and under what conditions; death and or disability. Importantly you need to ensure your beneficiaries are aware of these arrangements and understand how and why the agreement was structured.
You need to consider under what circumstances a benefit would be required. Typically it would be on death but may also include the inability to work as a result of Total and Permanent Disability and in some cases if you experienced a major Trauma or Crisis event such as Heart Attack or Cancer.
You will need to get advice on determining the quantity of insurance, the type of insurance cover and for what purpose; to protect the business and or the shareholders. You should consult your accountant for assistance in determining the value of the business. You also need to be aware of the taxation consequences of how the insurance is owned. Furthermore you need good legal advice from an experienced Estate Planning Lawyer who is experienced in providing advice in this area.