Buy/Sell insurance is designed to manage the risk to the business if a business owner is forced to exit due to illness, injury or death. Buy/Sell insurance pays a lump sum that ensures the remaining owners can acquire the departing owner’s equity, and continue to run the business. It also enables agreed compensation for the share held by the departing owner or their estate.
Buy/Sell agreements are sometimes likened to a ‘business will’ as they can help minimise the risk of:
- Remaining owners needing to sell the business or to take out additional borrowings to pay out the departing owner or their estate
- Assets being frozen due to legal issues created by the departing owner, their family or estate
- A departing owner’s family deciding to become an active business partner, against the wishes of the continuing partners
- The departing owner’s spouse or family taking up their legal right to claim business profits without working in the business
- A departing owner’s spouse or estate selling their share to an unsatisfactory third party
The risks that can be covered by Buy/Sell insurance are:
- Death of a partner (life insurance)
- Total and permanent disability (TPD insurance)
- Trauma such as heart attack, stroke, cancer and paraplegia (trauma insurance)
An important element of the Buy/Sell agreement process is reaching consensus on how the business is valued. Current market value is commonly used, and should be updated regularly. Other valuation methods include indexing the value to inflation, or to the expected business growth rate. As insurance premiums will vary due to differing age, health and other underwriting requirements, it is important to determine how premiums will be paid, and the most appropriate way of sharing costs.
There are a number of options available for insurance policy ownership, including self-ownership, cross-ownership, insurance trust, business entity and ownership by a superannuation fund trustee. The potential for ownership changes, and tax implications, including income tax, capital gains tax, and fringe benefits tax should be considered when determining the optimal structure. Buy/Sell insurance is a vital element of protecting your business. The arrangements can be complex, and every business’s requirements are unique, and expert advice is required.