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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 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 per cent 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.

Many businesses would be insured for an event such as death but many wouldn’t be insured to cover a default event such as insolvency, 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, if and 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 strategic plan.

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

For example - most businesses will have some sort of Key Person 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 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 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.

Superannuation can also be a tax effective way to provide some of the insurance requirements.

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.

Author: Mathew Kidd, Matthew is a Director of Grant Thornton Wealth Investment Management and is based in their Sydney office. Prime Super has established an alliance with Grant Thornton, one of the world’s leading accountancy and business advisory firms, so that members are able to benefit from their strong experience in the family and privately owned business sector.