The operations of most small businesses rely on at least one or two pivotal people: usually the owner and perhaps a valued employee.
If one of these key people were to experience a major illness or injury, or perhaps die, there is a good chance that the business would struggle and perhaps even fail.
Putting the right plans in place.
Small businesses are usually structured as a sole trader, partnership or company. In each case, the owners should put plans in place to make sure the business can survive the temporary or permanent loss of a critical person.
This contingency planning involves two elements: documenting how business ownership is to be transferred if certain events occur, and taking out insurance to provide the business with the financial resources to continue operations.
The right documentation.
Documenting how and when an owner’s share is to be transferred following serious illness, injury or death prevents many problems and disputes, especially where there are multiple owners. Having a succession strategy and buy-sell agreements in place will help the business to continue to operate without interruption.
A succession strategy involves identifying potential future owners of the business and preparing them for that role. Buy–sell agreements detail what happens to an owner’s share of a business if a specific event occurs. Common events include death, divorce, long-term disability, retirement and bankruptcy. In most cases, the outgoing owner (or their estate) will sell their share to the continuing or surviving owners.
The right insurance.
Most buy-sell agreements are funded using an insurance policy with cover for death, total and permanent disability and trauma. But it may also be appropriate to take out other forms of insurance to fully protect the business.
Business revenue, profit and potentially its value will be affected if an owner or an important employee is unavailable to work in the business. Taking out keyperson insurance, income protection insurance and business overheads insurance can provide additional funds for business expenses and help ensure it continues to operate in the short and long term.
Case study 1
Scott is a plumber and runs his own business as a sole trader. He employs Daniel part-time to look after the office administration, schedule work and organise orders. He has an apprentice, Riley, who is in the second year of his trade and still requires extensive supervision. Scott’s business turned over $470,000 last year and he received a personal income of $80,000.
On the advice of his financial adviser, Scott put a comprehensive insurance plan in place last year. This proved to be a wise decision because during his annual ski trip he tore his anterior cruciate ligament. The injury required extensive surgery and rehabilitation.
Scott was unfit to work as a plumber for four months, during which time his personal income protection policy paid him a replacement income of $5,000 each month.
Scott’s business overheads insurance policy provided a monthly payment that covered ongoing expenses such as Daniel’s salary, rent for the business premises, utilities and phone. It even enabled Scott to employ a qualified plumber on a temporary basis to supervise Riley and complete outstanding jobs.
Taking out the right insurance meant that Scott’s business could continue operating without him, rather than collapsing under financial pressure.
Case study 2
Manu and George run a catering business as a partnership. The business has grown substantially in recent years and now employs three full-time and one part-time staff and turns over more than $3.5 million annually.
Manu suffers a serious heart attack. Although he recovers well and remains physically capable of working in the business, he decides that it’s the right time for him to leave. He wants to spend more time with his family and perhaps find work with less pressure and stress.
Manu and George have a buy–sell agreement and have a funding plan that includes insurance. The trauma insurance policy covers Manu’s medical condition and pays out a lump sum, which is used to fund George’s purchase of Manu’s share in the business. As a result of this planning, the business can continue operating with minimal disruption.
If you would like to discuss your small business needs and the right type of insurance for you and your business please contact our specialist advisors to discuss this matter further.
Fullagar, C. (2012) “Trauma insurance and the changing definition of a heart attack”, Money Management. www.moneymanagement.com.au.
Attwood Marshall Lawyers (n.d.) “Buy sell agreements”. www.attwoodmarshall.com.au