Best Strategies to safe guard your business
Starting a business takes a lot of work. Growing something from a mere concept into a successful, fully operational company takes money, dedication, and a lot of sleepless nights. That’s why, it comes as a bit of a shock when business owners who have poured their heart and soul into their business, neglect very basic necessities such as succession planning, buy/sell agreements, and key-person insurance.
What are these, and how can they make or break your business?
Mark and John are good friends. They decided to open a pet grooming business in Melbourne. They hired a groomer and a few other people to run their business. Mark was handling sales and marketing, while John handled all accounting and bookkeeping. They worked hard and grew their business into a corporation worth around 2 million dollars. Their groomer; Mary; gained nation-wide fame and was sought after by celebrities to groom their pets.
One fateful day, one of their four legged clients; a Rottweiler; bit John in the leg and while Mary was trying to control him she slipped and fractured her elbow. She was hospitalized for a couple of days, and off work for 3 months as she couldn’t use her arm properly. The business had workers’ compensation insurance that covered Mary’s hospital bills, rehabilitation, and wages for the months that she was off work. However, while Mary was recovering, customers refused to have their pets groomed by another groomer, thereby losing the business thousands of dollars.
John’s wound was infected, he then had a heart attack and died few months after the incident. His business shares were then inherited by his ex-wife and two kids. Mark found himself faced with two choices:
He could either allow three people who knew nothing about the business to become his new business partners, or he could buy them out.
The payout figure was around 1 Million Dollars.
Mark could either sell John’s share to a new business partner, liquidate the entire business and split the money with John’s estate, or take out a loan to pay them out. All options were sub-optimal and costly.
So how could they have prevented this from happening?
There are 3 vital insurance plans that should have been taken out to protect the business. These are:
- Keyperson insurance: this is a life insurance policy that a company purchases on the life of an individual considered critical to the business, whether an employee, partner, or a top executive. This plan can help cover the business’s financial losses in the event of the death or disablement of the key person.
- Buy/sell agreement: this is a type of exit strategy that is put in place by the owners of a company that goes into effect in specific events, such as the death or disablement of one of the shareholders. A buy/sell agreement allows the remaining owners to exercise the ability to force the departing owner or his/her beneficiaries to sell the inherited shares to the remaining owners. It is funded by life insurance policies taken out on the owners’ lives by the company for the estimated amount of the owned shares. This sum is paid to that departing owner’s beneficiaries in the event that they are asked to sell.
- A succession plan: this is a legally binding document that formally documents the preferred measures that should be taken in case of death or permanent disablement. It usually includes multiple exit strategies, a clear definition of the events that would trigger the exit clause, and a strategy of what the exit would look like. It can also name the person that would replace the departing member and how they would be trained.
This situation may seem a little far-fetched, but that is what insurance plans are for. They protect us from unforeseen events. If your business has one or two people who are key to keeping it running, it may be prudent to take out keyperson insurance plans on these people. Apart from being a tax deductible expense, it is your cheapest option.
Having the basic business insurance plans is not enough, you have to have a succession plan that includes buy-sell agreements with defined exit strategies. Many businesses are sold insurance policies owned by the wrong entities or with the wrong beneficiaries named. Some didn’t even have any agreements in place, which resulted in the beneficiaries of the deceased partner receiving the insurance payout, but due to the absence of a proper exit strategy agreement, continuing to have ownership of the shares. And this is not only unhelpful for the surviving partners, but also very damaging for the business.
Don’t set yourself up for failure, talk to one of our experts now and save yourself a lot of trouble (and money) down the line.