While many owners of small-and-medium-sized businesses won’t hesitate to insure their physical assets, they often overlook the importance of insuring themselves.

Most small-and-medium-sized enterprise (SME) owners would readily agree it makes sense to protect their assets. Yet many neglect to insure themselves and other key people in their business in the event of death, disability, illness or injury.

The long-term absence or loss of essential personnel can be extremely detrimental to a business. It can also have a huge impact on each owner’s interest in the business.

Insurance is the cornerstone of any good succession strategy, says NAB General Manager of Wealth, Business Banking, Iain Rogers.

While owners may focus on voluntary succession planning, growing the business, bringing in new partners, planning what to do with the business when they exit it – they are far less likely to consider events beyond their control, that is, involuntary succession planning.

“Insurance is often the most practical and cost-efficient way to fund these events,” says Rogers. “It gives certainty over cost and certainty over outcomes.”

Protecting a business

Many growing and established businesses rely heavily on the skills and intellectual property provided by their owners and other key people. “Particularly if you have one or two key people that are responsible for a large part of the company’s revenue, the impact in terms of business growth and business sustainability can be very large, not just in year one but for an extended period,” says Rogers.

It therefore makes good business sense to insure these people in the event of death, total and permanent disability, or a critical illness. Even when it may be possible to absorb a resulting reduction in revenue into a business’s current-year profits, or accumulate a reserve, insuring key people can be a less expensive and more convenient alternative. It can also provide the certainty a business needs.

Guarding assets

Taking on debt can be crucial to starting a business or funding growth. It becomes problematic, however, if the debt can’t be serviced.

“Often personal or business assets are held as security against the loan. They are the ones that are at risk if paying the debt becomes a challenge,” says Rogers.

Problems can arise if an owner or another key person is lost to the business temporarily or permanently. In that case the business might have difficulty meeting its loan commitments. If a lender had real concerns regarding a businesses’s ongoing cash flow position, it is possible that an early loan settlement may be requested.

One way to reduce these risks is for the business owner to insure themselves and other key people in the event of death, total and permanent disability, and critical illness.

“If the loan servicing can be assisted through an insurance payment, it takes that pressure off and allows funding to bring someone else into the business. Or it can take the pressure off the cash flow,” says Rogers.

Succession planning

If a business owner passes away without having any arrangements in place for their business holdings, then those interests will usually be distributed in line with the owner’s will or to their beneficiaries. Those who inherit the business interests could then be entitled to the same management and financial rights as the business owner who passed away.

This may not only lead to complications with remaining owners, but it may pose as a challenge to the new owner who might not have the requisite skills, or desire, to assist in the running of the business. Even if the new owner wishes to sell their interest in the business, the remaining owners may also have issues with how they would fund the buyout, or come to an agreement amongst all parties on the price.

Similar problems could arise if an owner becomes disabled and is unable to work in the business again.

One obvious solution is a buy-sell agreement, particularly if the business is one that holds considerable value.

This involves:

• a transfer agreement¹ that outlines what will happen to each owner’s business interest if certain events occur and how the interests will be valued;
• a funding agreement that outlines how the money will be financed in the event of an ownership transfer and who will receive it.

There are a number of ways a buy-sell agreement can be funded. “For many businesses the most appropriate option is to fund a transfer of ownership through an insurance scheme,” says Rogers.

To find out more about what you can do to protect your assets, business revenue and business ownership, speak to a financial adviser who specialises in business insurance strategies. A financial adviser can also review your insurance needs over time to make sure you remain suitably covered.

1. The business interest can also be transferred through the partnership agreement, unit holders’ agreement or shareholders’ agreement.

Iain Rogers heads up a dedicated team of 62 people specialising in SME business protection.

This article was first published in Business View magazine (Winter 2015). For more articles and interactivity, download the iPad edition of Business View for free via our app, NAB Think.

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