by Lachlan Ashelford
Business owners are extremely busy people who, out of necessity, end up working in the business from an operational perspective, leaving them very little time to plan for the medium-to-long-term. As a result, one area that is often overlooked is insurance, though it’s essential to business succession.
The death, disability or injury of a business partner or key employee can have devastating implications for a business. The reasons for this are outlined below.
- A buy/sell agreement is a contract funded by a life insurance policy that can help minimise the turmoil caused by the sudden departure, disability or death of a business owner or business partner.
- Buy/sell insurance pays a lump sum if a business owner or a business partner dies or suffers a severe illness or injury and cannot stay in the business. The Insurance proceeds help ensure that the remaining owner(s) can acquire the departing owner’s share and continue running the business, and help ensure the departing owner or their estate will be compensated for giving up their rights to the business.
- This assures the remaining owners that the departing owner’s share of the business will not pass on to someone unsuitable to be an owner, e.g. the spouse of the departing business owner.
- This also assures business continuity for customers, creditors and employees.
I have recently worked on buy/sell insurance for a medical-related company that was recently purchased by two individuals. The purchase price of the business was $1.6m. The family trusts of each of the individuals are the effective owners of the business.
In order to protect each owner and the business itself, an $800,000 life, TPD and trauma insurance policy was taken out by the family trust of each individual on the life of each individual. In the event of a claimable event for either individual, the insurance proceeds would eventually flow to the family trust of the exiting business owner and the ownership of the company would pass to the family trust of the continuing business owner.
Key Person Insurance
- Key person insurance is insurance on the ‘key persons’ in a business. These are the people who are crucial to a business, and whose absence would significantly impact the business financially.
- A company purchases an insurance policy on its key employee(s), pays the premiums, and is the beneficiary of the policy. If a key employee unexpectedly dies, is totally and permanently disabled, or suffers a critical health event, then the company receives the insurance payment, which can be used for expenses until the company can find a suitable replacement, or if necessary pay off debts or distribute money to investors.
Case Study: Medical
The medical-related company referred to above required key person insurance. Both of the owners are key to the performance and success of the business.
They both perform separate and differing roles within the business. In the event either could not work within the business in the future, it would likely cost $250,000 p.a. to pay the wage of a suitable replacement. As a result, to protect the business, a $400,000 life, TPD and trauma insurance policy was taken out by the business on each individual.
In the event of a claimable event for one of the key individuals, the insurance proceeds would flow to the business and allow the business to employ a new key person in the departed key person’s role for the following 18 months and assist the business to continue as a going concern.
How We Can Help
If you would like to talk to us about the insurance implications of your business succession plan, simply contact Lachlan Ashelford using the form below or by calling 02 4969 6600 and we can arrange a complimentary initial discussion.