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75% of businesses have some form of business debt & 59% would cease trading within 12 months of losing a key person
Business Protection safeguards a company’s financial future against the unexpected loss of a key person or owner
Have you considered who within your business is key and what their loss could mean for you? Will operations or profits be affected? What time and money would be needed to replace them?
Many businesses have a variety of loans to help grow or expand, maybe an overdraft and possibly a commercial mortgage or if the directors have provided finance on a personal basis, directors’ loan accounts.
With most businesses reliant on a small number of key people to generate their revenue – would your business be able to continue to repay its loans if something happened to one of them? What would happen if it couldn’t, and the loan was recalled? or if you had to repay a director’s loan account?
One of the great risks of a business partnership is that one of your colleagues may die, with his or her share of the business passing to someone else. That person may have little interest in the business or – at worst – may be hostile to your objectives.
Shareholder protection sets out the procedures and policies to help ensure that you retain control, and have the necessary funds to do so
Directors’ Life Insurance
Much like a traditional life insurance policy, your family will receive a lump sum should you pass away, however by paying the policy through your business as opposed to your personal account you could save up to 49% on the cost as it is excluded from employer and employee national insurance and is treatable as a tax-deductible business expense
Chris Anderson talks us through the business protection options for small and medium sized businesses.
What is business protection insurance?
Business protection helps protect the most valuable assets within any business: the people within it. We could be talking about the owner, shareholder or partner, top salesperson or anybody whose expertise, relationships and contributions are critical to the company’s profitability.
Business protection helps companies survive financial disruption, disputes or continuity issues that might arise when a shareholder or a key person takes ill or dies. When that happens it creates massive uncertainty within a business. Business protection is part of a risk management strategy that provides a vital cash injection to help minimise any disruption to operations and profit.
Why is business protection important for small businesses?
For most SMEs a particular talent, expertise or responsibility lies with a small number of people, the same people responsible for generating most or all of the profit, and this generally creates a higher degree of risk. A Legal & General study showed that 52% of companies close within 12 months of losing a key person.
Imagine an owner or key employee is no longer there and the financial strain that puts on the business. There are also continuity issues – on the death of a shareholder or partner, you could lose control because their shares pass along with their estate, potentially to their family. Profits could suffer if your top salesperson becomes seriously ill. Bank overdrafts or loans could be called in or terms could be tightened from suppliers.
I know of a million pound turnover business that was run by a father and his two sons. When the father died, a loan was called in that the business didn’t have the cash in the bank to pay. Lenders were too nervous to provide credit because the father had run the business for years. He was the lenders’ point of contact and had the relationships with the clients.
The business couldn’t actually raise the capital to pay back that loan and in the end, this very successful business had to close. But the thing about most SMEs is that it’s not just the business that suffers. Both those sons had a wife and children, who lost their main household income as well.
What types of business protection insurance are available?
1. Key person protection.
A key person is an owner or employee that’s considered to be crucial to the running of the business, and whose contributions would be difficult to replace. Within a SME, the loss of a key person and their absence normally creates a significant disruption and cash flow issues within a business.
Consider the people and roles within your business that are critical to your success, whose absence would significantly impact day-to-day operations. There may be someone with specialist skills or knowledge that will be difficult to replace, or individuals who contribute significantly to generating revenue.
You should then look at the impact their absence would have and put plans in place should that happen. Key person cover is there to lessen that financial blow to the business and ensure continuity.
Businesses can use the funds for various different things like
- Hire consultants to complete certain contracts
- Fund recruitment costs to replace the vacant position
- Cover training costs to fill skills gaps
- Repay outstanding business loans should they be called in
- Mitigate any loss or decline in business revenue
I would encourage all business owners to seriously consider key person cover as part of their risk management strategy.
2. Shareholder protection.
Following the death of a shareholder, their shares are going to become part of their estate which usually goes to the family. That could mean the family then owns a percentage of your company.
This type of policy allows the other shareholders to buy back the shares from the family, for everyone’s benefit. The business can keep the shares and retain control and the family receives financial support in their place.
The issue is that you don’t know when someone’s going to die or what the value of the company will be at that point. So how can you be certain you’ll have the money available to buy those shares? It creates a continuity risk.
If the capital isn’t available to purchase the shares, you might have just lost a business partner and inherited a shareholder with little interest in the business or even worse a new shareholder with a lot of interest with no skills or experience, they have the potential to disrupt day to day operations and long term that could eventually lead to the companies closure
Without retaining ownership of those shares, you’re essentially losing control of your business.
The family is also free to sell their shares, possibly to a competitor or someone you have no interest in working with, leaving you stuck with a new unwelcome partner.
Or it could be the family is willing to sell the shares but the business can’t afford them and no third party has come forward leaving financial difficulty for both the business and the family. Uncertainty, disruption and disputes are the most common problems businesses face on the death of a shareholder.
Shareholder protection creates financial and operational certainty for businesses. Company valuation methods are agreed on, and it creates certainty for the shareholders. They know that in the event of their death or critical illness, their shareholding can be purchased for a pre-definable sum.
Your family benefits and your business benefits.
3. Loan protection
Another Legal & General report showed that 75% of businesses have some form of business debt. And it can often be a good thing, used to help grow the business, it might be an overdraft, a loan, commercial mortgage, or a director’s loan account.
And while the business is ‘servicing its debt’ there’s no problem, but what happens if it can’t? What if a key person and loan guarantor pass, how is their passing affecting your overall profitability first of all and now consider if a loan is called in on top of that.
Could these debts be repaid immediately without causing any further disruption or cash flow issues in the business?
The first step is to identify exactly who within the business has liability for each loan, along with their relationship to it – they may be solely, jointly or severally liable for the repayment
There is an even greater risk where guarantors have provided a personal guarantee. This essentially puts your personal assets on the line. If your business can’t service their debt your creditor has the right to come after your personal assets including your home which puts your family at risk.
Many business owners are unaware that a director’s loan account has to be repaid on death. Which again could create further financial difficulty to go along with the death of a key person and the overall effect that has on the business.
Business loan protection will help you clear the outstanding business overdraft, a loan or commercial mortgage so your business can continue to function and minimise disruption.
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Business Protection (Part 2)
We continue the conversation about business protection with Chris Anderson.
What is a relevant life plan?
It’s the same as a normal life policy except the business pays for it, not the individual
That has a couple of advantages personally and for your business. Because the business is paying the premium there are tax advantages you don’t get as an individual.
You could save up to 49% on the overall cost of your life insurance. Employees of sole traders including a spouse, ltd company directors and any member of a LLP can all benefit.
A personal policy of £40 p/m turned into a relevant life plan as a higher rate taxpayer would save you £350 a year, over the full term of your policy that’s likely to be many thousands of pounds.
The second thing is that It can also be used as a death in service benefit for your employees. Where you’ll both receive advantages you wouldn’t as an individual
What factors should businesses consider when choosing a business protection policy?
Before you consider any kind of protection, you need to complete a full analysis of your business. All the considerations we talked about earlier, with key people, shareholders & different loans.
What does their loss look like for you as a business over the next 12-24 months?
And if it was you who died what would you like to see happen for your business and your family.
What are the key differences between business protection insurance and personal life insurance?
Protection in general is there to provide a safety net and financial security in a time of disruption be that personal or business. Personal protection focuses on providing you and your family with the financial resources to weather a storm – and business protection is no different. But instead of that money being paid to you personally, it gets paid to your business. It gives a business a financial lifeline when it needs it most.
What are the tax implications of business protection insurance?
Relevant life plans are tax advantageous. But whenever we take a look at key person, shareholder or loan protection there are different guidelines and outcomes that depend on various factors.
We’re here to make sure you get the most suitable solution for your needs.
What are some common misconceptions or myths about business protection insurance?
I don’t think there are too many misconceptions – because it’s a really underrepresented area of financial advice both in terms of awareness to consumers and the number of advisers who offer help in this area.
Aside from that, Something business owners might often think is that their accountant would provide this type of advice. But this is outside their scope. A specialist financial adviser is key.
How do financial advisors help businesses with protection insurance?
We’re here to take the complexity out of it. We want to help you analyse your business, look at the what if scenarios and talk through the potential solutions.