The Terrible Risks Facing Your Business If You Haven't Prepared For Death Cover
As a business co-owner, being exposed in the event of the death or disability of another co-owner can immediately cripple a business. Fortunately, getting properly covered is easy.
Business owners all bring something key to the table. It may be their relationships, their experience, their technical ability or their access to capital.
The loss of one of those key people is not only a tragic event in and of itself, but if not planned for, can also mark the death of a business. Ensuring that the right form and levels of protection are in place beforehand – and remain current – is not a trivial matter, but with the right assistance, can ensure that your business continues.
Co-owners are not the only ones at risk
Consider what could happen if one of three equal business co-owners passes suddenly. The ownership interest passes to the deceased’s estate. The shares could then pass to their spouse and be sold to any interested bidders to fund estate debts or duties.
The remaining owners are unable to make key decisions, raise financing or otherwise adapt to this loss while the shares are tied up. Clients sense the trouble and part ways.
The shares may eventually pass to a party with vastly conflicting objectives for the business. Aside from consuming management time and effort, this could mean the end of the business – a loss to all owners and staff.
The remaining owners are not the only ones at risk. This business interest may form a significant part of the deceased’s planned provision for their spouse and heirs.
Without protection, the value of those share may be realised far below their fair value, possibly zero if the business should fail, leaving the beneficiaries with less than envisioned.
Further, investors, lenders and staff are also at risk and should be concerned when a business hasn’t planned for these sorts of events. There is no such thing as getting protected too soon.
Shareholder protection relies on knowing the business value
A common form of protection used in these situations is a buy-sell agreement. Here, all owners agree that, in the event of death or disability of any owner, the shares will be immediately bought by the remaining owners.
Insurance policies are taken out on all lives to ensure that the remaining owners have enough funds to purchase these shares.
The only thing as certain as death, is tax. The nature of the policyholder, the life assured, the sums assured, and the structure of the buy-sell all impact the levels of both premium and tax paid by each party.
Alternative routes, such as having the company buy-back the shares, should be considered, but each have their own consequences. Where owners make use of (family) trusts, holding companies or other corporate structures, the considerations can get very involved, very quickly.
Underlying all of the above is the price at which those shares will be sold, and this is informed by the value of the business.
If the sale price is too high, SARS may intervene to apply additional tax. If the sale price is too low, the seller(s) (ultimately the deceased beneficiaries) lose out on the value of the business.
If the value is not updated regularly or is contested by the insurer, the claim may be denied, leaving all parties back at square one.
Understand your value
Ultimately, either you, a partner or an expert in the field need to understand the intricacies and structure of these types of agreements. You need to ensure that the business is valued reliably and that when it matters, claims are settled and that SARS is comfortable.Your business may be the biggest asset that you leave behind and ensuring that your partners and your beneficiaries are protected should bring peace of mind to all owners, as well as any party (investor, lender, staff) that have a vested interest in the continuity of your business.
Gareth Watson is an actuary, consultant and co-founder of iBizValue, a firm specialising in business valuations and corporate finance projects for small to medium companies. Having worked at both large and small multi-national companies, Gareth has developed a keen insight into the value drivers for a range of businesses. Contact Gareth at firstname.lastname@example.org.