How Buy/Sell insurance helps secure your business’s future
Does your business have a succession plan when a partner passes away or becomes seriously ill? Discover how business owners utilise buy/sell insurance to protect their business and the future of their family.
As of 2024, there are 2.6 million actively trading businesses in Australia, of which a large portion were established as partnerships. In most cases, partners in the business offer expertise, equity, or play vital roles in the operations–making it difficult for the business to lose them.
While these businesses vary in size and structure, the majority may face the risk of losing a business partner, whether through an untimely death or diagnosis of terminal illness. In a business, despite unfortunate events, the business must continue as usual.
In this article, we share how successful business owners explore the buy/sell insurance strategy to secure their business’s future.
What are the Financial Risks of Businesses
If you have multiple partners in your business, then pay attention to these business risks you may encounter in the future:
Partners’ Liabilities and Debts
When you lose a partner in the business, it will not excuse your business from paying the business’s loans and performing your liabilities to your clients and other stakeholders.
Continuity of the Business
Another impact of losing a business partner is the disruption of business operations, which can lead to financial instability. This usually happens when your partner is in charge of the business operations.
Shares Valuation and Buy-out
It can be difficult to determine the valuation of your departed business partner’s shares. In most cases, this can cause conflict between the partner’s family and your other partners.
What can be more difficult for you, as the business owner, and for other partners, is funding the buy-out of the shares. For some businesses, this can cause financial trouble and instability.
Legal Fees and Administration Costs
Resolving the dispute and updating the business registrations can be costly and time-consuming. Adding these costs to the buy-out can derail your business’s finances.
Impact on Business Relationships
In some cases, the loss of a business partner may affect your relationship with your clients, suppliers, or creditors. Getting them back may require funding to re-establish the relationship, such as hiring a specific person to do the job.
What is Buy/Sell Insurance?
Buy/sell insurance is perfect for businesses with multiple partners and shareholders. In conjunction with a binding agreement, the proceeds of these benefits are paid to the estate/family of the exiting partner in exchange for their equity in the business. The remaining partner receives the equity, which they can use to re-establish the business after a critical loss.
Here are some of the benefits of having buy/sell insurance:
Peace of Mind for All Partners
Ensures that if a partner is forced to exit the business due to illness, injury or death, their family receives fair value for their stake in the business. It also ensures that the remaining shareholders retain control of the business they have worked so hard to build.
Funds to Acquire the Deceased or Disabled Partner’s Shares
The policy provides funds to the other partners to buy the departing partner’s shares. This can prevent external individuals or entities from buying the departed partner’s shares.
Pre-determined Values Remove Friction
The agreement is developed by the shareholders of the business, and this stipulates the valuation for the business. This provides great value to shareholders as they know that their family will receive a value in line with what the shareholders believe to be fair. It prevents the family members from needing to negotiate a sale with the remaining shareholders.
Remaining Shareholders Retain Equity
This approach allows the remaining shareholders to retain control of their business, preventing them from becoming partners with the family or estate of the outgoing partner. In the absence of an agreement of this kind, the family/estate of the partner that has suddenly left the business would typically inherit the equity. This creates a scenario where you may become business partners with an individual or entity that is unfamiliar with the industry, and also a scenario where they have to be consulted regarding operational decisions.
Fund for Hiring and Training Employees
When your partner plays a crucial role in the business, you may opt to use part of the payout from the insurance to hire and train an employee to replace the role.
Funds for Legal and Administration Fees
Processing the sale of the partner’s shares can incur legal and administrative fees. Payout from business insurance, such as buy/sell insurance for business owners, can cover these costs. Neither the business nor the remaining partners has to take the costs out of their pockets.
Policy Ownership Structures for Buy/Sell Insurance
Depending on the business’s structure, business owners have multiple options when owning buy/sell insurance – to ensure a smooth business succession.
- Self-ownership – This is the simplest structure where the insured is also the policy owner–this is usually the business owner or a partner. This ownership’s portability is its biggest advantage. It allows the insured to maintain the coverage even if they leave the business.
Note: It can be complex to manage the buy-out fund in this type of structure.
- Cross-ownership – Each partner owns the life insurance policy of the other. When a partner passes away or is diagnosed with a terminal illness, the other partner receives the payout to fund the share buy-out. However, changes in ownership require updating the policy. This method seldom makes sense as it would require you to transfer the funds back to the family of the departing partner in return for their equity.
- Insurance trust – This requires the business to establish an insurance trust to own the policy. The business then nominates trustees who will oversee the fair distribution of the benefits amongst the partners.
- Business entity – Some may prefer for the business to own and manage the policy. However, this ownership structure may raise tax concern that needs deliberate planning.
- Superannuation fund – In some cases, the partner’s superannuation fund can own the policy, making this an affordable option. However, accessing the benefits can be complex, which can make funding the buy-out challenging.
What is a Successful Business Succession Plan?
Businesses with multiple owners or partners should have a well-defined business succession plan. This provides peace of mind to the partners, knowing that the business will have a continuity plan when a partner has departed.
Elements of Business Succession Plan
Early Planning
The earlier you can establish the succession plan, the more time and energy you will have to focus on running your business.
Identifying the Successors
Whether they are family members, existing employees/partners, or external candidates, being able to identify them early and introduce them to your partners is important.
Your business successors must have the right experience, skills, and knowledge to run your business. Otherwise, you may need to provide the necessary training and mentoring.
Business Valuation
To be able to determine the accurate and fair valuation of your business at the time of succession is important. This is where your departing partner’s shares will be valued to be bought back by you and your other partners.
Legal and Financial Structuring
During a business succession, you should consider the changes within the business’s legal and financial structures. These include ownership transfers, contracts, tax implications, managing the cash flow, and funding the transition.
The complexities of these processes can be daunting if not planned early.
Communication and Stakeholder Management
Having constant and open communication with your stakeholders, suppliers, customers, and employees is key to maintaining trust and stability within your business.
Buy/Sell Insurance for Business Owners
This critical component in business succession provides a source of funds to the remaining partners to buy back the shares of the departing partner in the event of untimely passing or diagnosis of terminal illness.
As a business owner, having this type of business insurance can ensure the continuity of the business, fair compensation to the departing partner, and financial security for the business and all of the partners.
Documentation
Like any business strategy, a well-documented and regularly reviewed business succession plan gives clarity on the process and provides accountability to the concerned individuals.
Get Specialist Advice on Buy/Sell Insurance with Curo
Taking out the right amount and benefits for buy/sell insurance for your business and your business partners will need careful consideration within your business and personal circumstances.
At Curo Financial Services, we provide expert buy/sell insurance advice to all types and sizes of businesses in Australia. When you work with us, you and your business can utilise our decades of experience working with hundreds of businesses with various financial goals and situations.
Our team only provides tailored and customised buy/sell insurance advice and plans to business owners to make sure that their risks are carefully identified and mitigated.
Interested in knowing more about how we can help you and your business? Send us a message, and one of our team members will get in touch with you.
Frequently Asked Questions
What happens when a business partner dies without buy/sell insurance?
A business may face several challenges when this happens. This may jeopardise the business’s operations, create conflict within the partners, or leave an external party to step in to buy the deceased partner’s shares.
Is the benefit amount of Buy/Sell Insurance tax-deductible in Australia?
The impact of taxes on the benefits of buy/sell insurance will depend on the type of ownership and the structure of the insurance. It is best to seek help from experts such as Curo to know your options when it comes to having tax-efficient buy/sell insurance.
How to customise a buy/sell insurance?
There are various ways of taking out buy/sell insurance, but in order to get a customised and tailored option, it is best to work with an insurance expert. Our team of experts will help identify the factors in choosing the best buy/sell insurance.
General Advice Disclaimer
General advice warning: The advice provided is general advice only and in preparing it we did not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of this advice, you should consider how appropriate the advice is to your particular investment needs, and objectives. You should also consider the relevant Product Disclosure Statement before making any decision relating to a financial product.
Factual Advice Disclaimer
The information I have provided you is purely factual in nature and does not take account your personal objectives, situation or needs. The information is objectively ascertainable and, therefore, does not constitute financial product advice. If you require financial product advice you should consult a properly licensed or authorised financial adviser.
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