June 30, 2016

The changing face of insurance

Setting up a new business is inherently risky. Insurance can help a lot – as long as you remember to revisit it as your business grows and changes.

The message is loud and clear: insure your business. And it pertains as much to the fresh new start-up as it does to the old, established company.

But what happens as your business grows, if you up your level of debt or bring a new partner on board?

Insurance is only effective as long as it meets your requirements and, in business, these can change considerably from year to year.

Run and Walk (RAW) Fitness partners, podiatrist Andrew White and general practitioner Joel Ang, are cognisant of this fact. In 2014 they purchased a gym and established a medical suite on the premises, including GP and other health services. “The idea was to have this synergistic operation where people moved through all the entities,” explains White.

Only 18 months into their business there are already signs that they need to adjust their insurance. The two men have hired several employees to run the various business lines, and are now set to take on a new partner. As they continue to grow, there will be good reason to consider whether they need to introduce, add or restructure their protection in the main areas of assets, revenue and owners’ equity insurance.

Sharing the burden

Of course, ownership protection was critical from the very start of the business. To this end, White and Ang took up insurance to cover their personal and business needs and also entered into a buy/sell deed to protect their ownership structure.

Such deeds typically involve:

  • 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; and
  • a funding agreement that outlines how the money will be raised to finance the ownership transfer, and who will receive it.

In the case of serious accident or death, this deed, together with the relevant insurance, means the surviving business partner will remain in control of the company while the family of the deceased partner is also looked after.

“The effects of critical illness or sudden death can spread well beyond the owner’s family, to employees, business partners and their families,” explains NAB General Manager of Wealth, Business Banking, Iain Rogers.

He has seen individuals dealing with grief or illness forced to take on extra responsibilities to keep a business functioning. “It’s common to see owners who have to return to work when they should be at home recuperating. We also see spouses forced into the business because they need the income but who are grieving and cannot add the value they otherwise might.”

To White, it’s ultimately about peace of mind: “We’re all working incredibly hard. You don’t want that to double or triple if your partner is suddenly unable to help with anything.”

Keeping up with the times

The fact that White and Ang are looking to bring on a new partner means that their needs could well change. “Their insurance and their buy/sell deeds will need to be amended at this point,” confirms NAB Wealth Senior Financial Planner Ben Waite, who helped them with their insurance plan.

White agrees that he and Ang need to review their insurance requirements. On the whole, however, he believes the burden will become more manageable as the three partners share the load and attendant risks. “I guess with regard to any sort of financial backing, if there are three doing it rather than two, there’s less risk put upon each individual as equity holders in the business.”

Sidestepping debt

Protecting the ownership structure isn’t the only issue, of course. When NAB funded the purchase of the existing gym business, it also provided cover for asset protection. “Should something happen to one of the directors, the other can rest assured the company will be debt free,” explains Waite.

Rogers underlines the importance of such cover. He says it’s common to see business income suffer in the early weeks after a partner or key employee dies or takes sick leave. Managers may have to reduce staff, and the business’s reputation can suffer from even a temporary disruption to cash flow.

Of course, should the partners at RAW Fitness take on higher levels of debt over time, it will be important that they adjust this insurance accordingly.

Not all forms of insurance suit RAW’s circumstances, however. The fact that it is a start-up means revenue protection is not deemed appropriate at this stage. “Due to costs, and because they don’t have a proven income stream yet on the medical side, we didn’t focus on revenue protection,” explains Waite.

Yet, as the business builds momentum, this is something else that could well change.

Protecting the family home

NAB General Manager of Wealth, Business Banking, Iain Rogers, says business protection is particularly important for owners who have guaranteed their business loan with personal assets. He recalls a two-man partnership where one partner died in a car accident. Business borrowings were guaranteed by their homes, and the surviving partner had to find other assets to borrow against to buy out the widow’s equity and remove her home from the loan.

These circumstances made an already traumatic situation even more difficult.

“With the benefit of hindsight, the right insurance for their business certainly would have made an already difficult time a lot less stressful and helped alleviate some of that hardship,” Rogers says. “The debts would’ve been cleared so her home would be released, and control of the business would’ve passed to the surviving partner.”

The two men ran a very successful business because each of them performed different roles, but that also made the business vulnerable when the skills of one were lost. The partner who died was the salesman, and when revenue fell the remaining partner had to try to take on that role.

“Revenue protection would have injected extra funds while the remaining partner recruited a new salesperson,” notes Rogers.

He says this example shows how appropriate insurance will preserve the value of a business through difficult times, but warns that it’s important for owners to obtain professional advice on the best solution for their business and personal circumstances. An experienced adviser will discuss risks, strategies and an affordable level of cover, rather than simply brokering a product. “It’s an area that requires expertise,” says Rogers.

“The effects of critical illness or sudden death can spread well beyond the owner’s family to employees, business partners and their families.”

This article was first published in Business View magazine (Issue 21).

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Disclaimer: NAB Financial Planners are Representatives of National Australia Bank Limited ABN 12 004 044 937, an Australian Financial Services Licensee, Registered office Level 4 (UB4440) 800 Bourke Street, Docklands VIC 3008, and a member of the National Australia Bank Group of Companies. Any advice in this communication is of a general nature only and has been prepared without taking into account your objectives, financial situation or needs. Before acting on any advice in this communication we recommend that you consider whether it is appropriate for your personal circumstances.
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1 The business interest can also be transferred through the partnership agreement, unit holders’ agreement or shareholders’ agreement.