IDENTIFYING THE RISK

In today’s competitive environment survival depends on the ability to respond to change. The change that could hit your business could be the loss of a key director/shareholder through death, disability or unplanned retirement.

Many small to medium size businesses rely on the complementary skills and abilities that shareholders bring to a business for day-to-day survival. Shareholders often undertake considerable personal financial commitment, bear the increasing responsibilities of compliance and invest much time and expertise in planning for the ongoing success of the business.

With so much at stake it is critical that every business have a business survival plan given the current economic climate.
 
What is a business survival plan? It is a guideline that outlines how a company will:

  • Manage cashflow, debt and expenditure
  • Manage service levels and marketing
  • Manage the untimely loss of a shareholder through death or disability
  • Manage a solid succession plan for loss of a shareholder on retirement

Most small business owners have a plan for the first two points, but many seldom know what they would do in the event of the last two points.FACT: Stats show the average age of Critical Care claimants is around 46.

FACT: The average age of death claimants is around 49

FACT: The average age of our Income protection claimants is around 47 - the average duration of claims is around 20 months. 

Given that most of us expect to retire when we reach the 60 to 65 age group, this snapshot of our claims profile shows that a crisis could bring our working days or our capacity to work to an abrupt end long before we could ever imagine.

COMPANIES ACT
Throughout a period of crisis the business will continue to exist as a separate legal entity with enduring financial and legal obligations. One of these ongoing statutory obligations is the prudent management of risk. The Companies Act 1993 Section S135 states that a director of a company must not “agree to cause or allow the business of the company to be carried on in a manner likely to create substantial risk of serious loss to the company’s creditors”. Will there be a loss to your business on the death or disability of a shareholder?

 

DEATH OR DISABILITY OF A SHAREHOLDER

It takes as little time as a few weeks after the death or disability of a shareholder for the impact on the financial bottom-line of the business to be felt. This could mean:

  • Possible restrictions on credit terms
  • Severely reduced ability to service debt
  • Foreclosure by creditors/lack of liquidity
  • Personal guarantees are called up placing personal assets at risk (in most cases estate settlements will be delayed as assets are frozen until guarantees are satisfied.)
  • Loss of key relationships/goodwill Public perception of instability/staff instability

LIQUIDATION

On the sale or liquidation of a business that has lost a key shareholder, the true value of a business is generally lost. A ‘fire sale’ situation may occur that may result in:

  • Stock sold at a loss
  • Fixed assets do not realise their book value
  • Debtors disputing their accounts
  • Substantial legal and accounting costs
  • The investment, goodwill and personal exertion that shareholders have put into the business over the years can be lost. It may also mean loss of employment for the remaining shareholders.

TRANSFER OF SHARES

The permanent loss of a shareholder could mean significant reorganisation and potential upheaval to the ownership structure of the company. Without a specifically designed plan to manage the consequences of death or cessation of a shareholder’s employment, ownership of share are automatically passed onto the deceased’s estate or fully retained by the outgoing shareholder.

HOW WOULD A TRANSFER OF SHARES AFFECT OTHER SHAREHOLDERS?

A deceased shareholder’s share of the business will form part of his or her estate and will usually pass to his or her spouse or children. Will the spouse or children contribute to the business? Will they get along with existing shareholders? Will they want to draw dividends rather than reinvest retained earnings? Will they accept reasonable salaries for work performed? These are all questions that one should consider and plan for.

The remaining shareholders may desire to purchase the estate’s interest. There may be issues relating to the willingness of the estate to sell, determining share value and the finance method of the acquisition of the shares. In the absence of funds to complete the transaction, the estate may seek an outside buyer. The availability of a suitable buyer willing to pay the desired price may be an additional challenge. These events could all cause conflicts that could potentially ruin the longevity of the business.

THE SOLUTION?

Whether the shareholder’s incapacity to work is permanent or short to medium term, it is in everyone’s best interests – shareholders, beneficiaries of the estate and family trusts, to formulate a contingency plan to ensure:

  • A predictable outcome in the event of crisis
  • Smooth handover of control and ownership on death or retirement
  • Financial reserves to offset loss and keep the business going through an adjustment phase

The two key tools in an effective strategy to preserve business value are an appropriately structured buy/sell agreement and a comprehensive risk insurance plan.


FUNDING THE SOLUTION

Cash is an important solution to most financial problems and no tool provides instant liquidity like insurance.
Fidelity Life’s Corporate Plan provides liquidity to fund the solutions to a business crisis at a time when other finance arrangements may be unavailable or heavily restrictive. Up to six lives can be included on the Corporate Plan with beneficial ownership of the various benefits under the plan transferred to separate entities as required. The buy/sell agreement should clearly outline the insurance policies to be effected to fund the agreement and the transfer of these benefits.

BUY/SELL AGREEMENT

A buy/sell agreement sets out the rights of shareholders in relation to shares in the event of death or disability. It can allow the surviving shareholder(s) or the company the right to buy the shares of the deceased shareholder at a pre-agreed value.

Under a specified range of conditions such as death, critical illness, resignation or retirement, the conditions of a buy/sell agreement come into force. This binding contract protects a business from unstable outcomes of changed circumstances by specifying:

  • A commitment from outgoing shareholders to sell shares and for remaining shareholders to buy them
  • A predetermined valuation method of the sale of the shares
  • The means of financing this share purchase

This provides advantages to the surviving shareholders including:

  • Control of ownership and continuity of the business
  • The assurance of a predictable outcome
  • Purchase price and method of payment is guaranteed
  • Enhanced reputation through the ability to meet statutory requirements
  • Stability for employees, creditors, suppliers and clients

The Outcome? Protection of the value of your business.

The outgoing shareholder will benefit from:

  • Guaranteed purchaser and a fair price assured in cash
  • Simplified administration by a commitment to a course of action as set out in the buy/sell agreement
  • Fair compensation

The Outcome? Protection of the estate.

The buy/sell agreement can be tailored to various company structures and the desired outcomes of a contingency plan. It is ideal for partnership situations such as accountants or lawyers.

 

Talk to your InsuranceNet Adviser for more information on how you can protect yourself and your business.

 

RISK OPTIONS

Life Insurance
A single lump sum is payable on death. This is ideal for securing loans, financing business situations and providing income to a surviving partner.

Total and Permanent Disablement
Linked to the life assurance benefit or as a stand-alone plan, this option enables a benefit to be paid if you become totally and permanently disabled. The payment is made after you have been absent from work for six months and fulfil the terms and conditions of the policy.

Trauma Cover
A lump sum is payable on the event of one of the specified critical conditions. This benefit can be linked to life cover or can form a stand-alone plan. This benefit helps meet the costs of a serious illness and subsequent recovery and it enables the insured to meet a number of financial obligations during a period of recuperation.

Life Care
Life Care Benefit is linked to life assurance and provides a lump sum equal to 20% of the sum assured if the insured suffers one of the specified conditions. Up to five claims can be made during the term of the policy with cover available for life. This is a cost effective way of retaining critical care cover throughout one’s lifetime.

Survivors Income
Sometimes referred to as Family Income Protection. This benefit pays a regular monthly income to the policyholder on the death of the life assured. This is an ideal way of replacing income that would normally have been received for a part of the working life of the deceased. A flexible range of benefit periods is also available.

Income Protection
This benefit protects a key person’s personal income during a period of disability by paying a monthly benefit if he or she is unable to work due to sickness or injury. Premiums are calculated on the basis of age, smoking status and occupation. The benefit, which will not exceed 75% of pre-disability income, is an essential form of protection from financial hardship if the insured is unable to work due to sickness or injury. Fidelity Life’s premiums take into account ACC’s responsibility to cover accident related claims in the first instance.

Business Overheads / Locum Cover
The liability of ongoing business overheads can be met with cover specifically designed to meet those costs during a period of disability. Business Overheads is ideal in situations where a key person is a partner. Alternatively the benefit can meet the cost of a replacement employee to carry on the business operations. Up to 100% of your share of business expenses or cost of a locum can be covered for the first 12 months of a claim reducing to 50% in the second year.