Personal Risk Insurance

When a principal in a business dies or becomes permanently disabled and unable to work again, the ownership of the business will often change. But how will the cards fall, who will the new owner be, and have you planned for this?

A business succession agreement can help you sell your business at the right price and to the right person, should something happen to you. It can also allow you to acquire a partner’s share of the business, should something happen to them.

Protecting your business interests

If you have one or more business partners, you need to ask yourself what would happen if you or one of the other business partners were to die or become permanently disabled, and unable to work in the business again. You may not want an ex-business partner’s beneficiary as your new business partner, but this is a real possibility if there is no business succession plan in place. Alternatively you may find yourself having to buy out your ex-business partner’s estate in order to keep your business, and you may not have ready access to that sort of finance.

What is a Business Succession Agreement?

A Business Succession Agreement is a legal document which sets out the wishes of the business partners, should one of them die or become incapacitated. For example, if one partner dies, it will normally allow the surviving partner to buy the deceased partner’s share of the business. The capital to make the purchase will often come from life insurance policies, taken out on the lives of each principal.

Why you may need a Business Succession Agreement?

A Business Succession Agreement, often called a Buy/Sell Agreement, can be of benefit where:

  • Two or more parties share the ownership of a business, such that they, or their trust or spouse, each own shares in a company, or units in a unit trust, that carries on the business;
  • One business principal dies or becomes disabled and the continuing principals want to ensure they are able to purchase the outgoing principal’s interest; or
  • The business principals want to ensure that their estate is paid a fair value for their interest should they die or become disabled

Using insurance to fund your Business

Succession Agreement

One of the simplest and most cost-effective ways to fund a Business Succession Agreement is by using a life insurance policy to provide all or part of the funds to purchase an outgoing owner’s interest. For businesses planning to fund a possible buy out of a Principal’s shares, there are a number of options for ownership of the life insurance policies.

Self Ownership

Self ownership is the simplest approach, where each principal owns a policy on his/her own life. Self Ownership can be an effective way to reduce the risk of Capital Gains Tax (CGT) applying on the life insurance policy proceeds.

When a principal dies or becomes disabled, the Business Succession Agreement reduces the amount that the other partner/s will have to pay for that departing principal’s share. The reduction in price is equivalent to the amount of insurance proceeds received by the departing principal or his/her beneficiaries. If the insurance payout equals or exceeds the value of the departing principal’s shares, the other principal/s will then become the new owner/s without having to personally fund the purchase of the departing principal’s share of the business.

Cross Ownership

Cross ownership involves the business principals owning an insurance policy over each other’s lives. Under this structure, CGT may be payable on any total and permanent disability (TPD) or trauma insurance proceeds received. On the death or disablement of a principal, the remaining principals receive the insurance payout directly and can use these funds to buy out the deceased or departing principal’s share. A legal Business Succession Agreement may also be useful.

Superannuation Ownership

Superannuation ownership is similar to self ownership, however the life insurance policy is held through a superannuation fund. On the death of a principal, the insurance policy will be paid into the superannuation fund, which will then pay a death benefit to the deceased’s nominated beneficiaries or estate.

Superannuation ownership can provide tax efficiencies in funding premiums but it can also create complexity, due to government restrictions on contributions and withdrawals. There may also be additional tax consequences at the time of claim, especially where death benefits are paid to non-dependant beneficiaries such as adult children.

Company Ownership

When the life insurance is owned by the company (or business) itself, the insurance proceeds from death, TPD or trauma are used by the company to purchase back the departed owner’s shares. The result is that the remaining owners will hold a greater percentage share in the business. As with the other options, company ownership has its advantages and disadvantages.

Other ownership options

As an alternative to the above options, the insurance policy is sometimes owned through a discretionary trust, or specially drafted insurance trust. The trustee will then distribute any insurance proceeds in accordance to the trust deed. Whilst these options can have certain advantages, especially for more complex businesses, specialist taxation advice is essential.

The importance of advice

Business succession planning is complex and the needs of each business, and its principals, are different. Your financial adviser can provide advice about business succession planning, tailored to the needs of your business. You should also seek professional tax and legal advice to help implement this type of arrangement. Speak to your Financial Adviser about the right type of cover for your business needs.

Interested in speaking with a financial adviser?

Contact Capital Advice Partners on 02 8920 3488 or use the form on the right today.

Personal Risk Insurance

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