A Financial Services Partners Adviser can help assess how business succession planning can help you protect what is important. They can work with your legal adviser and your accountant, where appropriate, to ensure the plan meets your needs and objectives.
What is business succession planning?
The success of a business can be severely impacted if a business owner dies or is unable to work due to illness. Incorporating a Buy/Sell agreement into a business succession plan can help to ensure a smooth transition of ownership to the remaining owners.
A Buy/Sell agreement ensures:
- that remaining business owners can continue to own and operate the business
- the departing owner or his/her beneficiaries can sell his/her share for a fair price
- the business can continue to operate with minimal disruption.
BusiNess owners need to ensure they can fund the departing owner’s share of the business. An insurance policy may provide an effective solution if the person dies or is unable to work due to disability or illness.
How does the Buy/Sell agreement work?
The Buy/Sell arrangement has two parts - a legal document and a funding mechanism.
Having a legal agreement in place can help avoid future disputes. The departing owner (or estate) will receive fair value for their share of the business and the remaining owner/s are able to continue to run the business the way they want.
Life insurance is often used to fund the purchase of the departing owner’s share. It is usually a relatively simple and inexpensive option and avoids the need for remaining owners to use personal savings or borrow money. Other funding options such as savings, loans or deferred purchase agreements to make payments over a number of years need to be considered for events like the retirement or resignation of one of the owners.
Ownership of life insurance
A decision needs to be made on who should be the owner of any life insurance policies. This should match the details included in the Buy/Sell agreement.
Available options include:
- Each person owns the policy on his/her own life. The insurance proceeds are paid to that person or his/her estate.
- This is a simple option as it allows you to retain control over your policy and makes it easy if you have new partners joining the business. As part of the Buy/Sell agreement, the receipt of the insurance proceeds can be considered as full or part payment for the departing owner’s business share.
- The proceeds of the policy are generally received tax free.
- All business partners are joint owners of an insurance policy over each owner’s life. The proceeds are paid to the surviving policy owner/s.
- This is a simple structure that may be appropriate if you do not expect changes to your business partners. As part of the Buy/Sell agreement, the receipt of the insurance proceeds can be used to buy the departing owner’s business share.
- Payments on death are generally tax free but a Capital Gains Tax (CGT) may apply in some cases. CGT may also apply to Total and Permanent Disability (TPD) or Trauma policies.
- Cross ownership is where each owner holds an insurance policy on the other owners. As part of the Buy/Sell agreement, the receipt of the insurance proceeds can be used to pay for the departing owner’s business share.
- This option may be complex if you have more than two business owners. It can create problems for CGT on TPD and trauma if the business owners are not close relatives.
- The insurance policies are owned by a discretionary trust set up to hold ownership. The insurance proceeds are paid into the trust and the trust deed determines how to pay the money.
- This structure provides you with flexibility, especially if you have a number of business owners or expect changes in owners or you need to own several policies for different purposes. It may increase your costs as you will need to set up and maintain a trust.
- Whether tax applies on insurance proceeds will depend on how the arrangements are structured and who receives the payments from the trust.
- The company running the business owns the insurance policies for each business owner and receives the money if the insured event happens.
- The company uses the money to buy back the departing owner’s shares. These shares are cancelled and the shares held by the continuing owners will effectively increase in value.
- Proceeds from term life policies are generally tax free. CGT may apply for TPD or trauma policies. The remaining owners may have a negative CGT impact on their shares as the value of each share will increase but there is no change to the cost base.
- Under this structure, each business owner’s superannuation fund will own the insurance policy. The insurance proceeds are paid tax free into the superannuation fund and is added to the person’s account balance. If the amount is withdrawn from superannuation, lump sum tax may be payable in some circumstances.
- As part of the Buy/Sell agreement, the receipt of the insurance proceeds can be considered as full or part payment for the departing owner’s business share. This option may create extra complexity due to the restrictions applied by superannuation rules. Legal advice should be sought.
A Buy/Sell agreement and insurance cover should be reviewed on an ongoing basis to ensure it continues to be appropriate for your needs.
Key Person insurance
If a key person is unable to work due to accident, illness or death this may have a significant financial impact on your business. A key person is someone whose inability to work is likely to result in a reduction of revenue and/or increased expenses.
Insuring your key people will enable you to receive a lump sum to boost the working capital of the business and ride through a potentially difficult period. This may be the difference needed to allow your business to keep running.
How does Key Person insurance work?
A term, Total and Permanent Disability (TPD) or trauma insurance policy is taken out with the key person as the life insured. If the key person is unable to work (due to illness or death), the policy pays a lump sum to the business (or policy owner). The business can use that money to replace the lost revenue or capital value that should be generated by the key person.
What kind of goals can Key Person insurance be used for?
There are usually two purposes for taking out Key Person insurance - maintaining revenue and capital.
A revenue purpose is focused on replacing income lost due to the key person being unable to work. For example, if your key person is a sales person. Other revenue purposes include recruitment costs to find a replacement and training of the new employee.
A capital purpose is used to replace capital if the key person is unable to work. This could relate to the need to repay creditors or repayment to the key person if they have loaned the business money. There may also be an impact on the value of the company.
Your Financial Services Partners Adviser can determine if business succession planning is right for you, after they consider your needs and objectives. They can also determine which other wealth protection strategies can best meet your needs.
Talk to us about how business succession planning and key person insurance might work for you.