What Insurances do Business Owners Need?
- May 1
- 4 min read
What Life Insurances do business owners need to protect their business?
When there are two or more business owners, and the business has a material value, then a Buy Sell Agreement should be put in place, funded by a Life and Total and Permanent Disability policy.
A Buy Sell Agreement is a legal agreement between business partners which lists triggering exit events and stipulates how to fund the exit of a business owner.
Commonly, a Life and Total and Permanent Disability Insurance policy is established for each business owner so that if they become disabled or die, the insurance proceeds are used to fund the purchase of the outgoing party’s share in the business, with the family receiving the proceeds of sale.
What are the benefits of a Buy Sell Agreement and Insurance?
Each business owner is guaranteed to receive the insurance proceeds equal to the value of their share in the business, rather than having to accept a ‘firesale’ value.
The remaining business owners are not forced to find cash to purchase the exiting business owner’s share of the business. Using either their own cash or a bank loan may not be feasible.
By receiving insurance proceeds from the Buy Sell agreement, it could offset or reduce the amount of life insurances you otherwise need to pay for personally or via your own superannuation.
It removes potential legal costs required to negotiate a sale when an agreement is not present. I have seen this play out in the past whereby a client incurred $50,000 in legal fees negotiating the exit price for the business (and it could have been even worse if the other party didn’t have the funds to facilitate it).
What is the process to set up?
To set up a buy/sell agreement:
A Business Valuer or Accountant would need to be engaged to value the business.
A Commercial Lawyer is required to draft the Buy Sell agreement
Finally, a Financial Planner selects the cover amounts (based on the business valuation) and finds the best insurer and structure for the business owners.
What are the costs involved?
The Commercial Lawyer and Accountant will charge a fee for their services.
Financial Planners generally receive insurance commissions from the insurer which can reduce or completely offset the fees that would otherwise need to be charged.
The insurance policy premiums can be paid for by either the business or individual directors. The Financial Planner will recommend who should pay by considering the cashflow of the business and directors personal situations, tax consequences, age difference of the directors and other factors.
Are there any other types of Insurances that are required for business owners?
When directors or other key people in the business have roles that only they can do, or would require a replacement to be hired if they were unable to work, then Key Person Trauma Insurance should be strongly considered.
For example, in a manufacturing business, if one director operates specialised equipment, and the other fulfils the duties of CEO, then neither may be able to replace the roles and duties of the other. Therefore, if they suffer a critical illness (trauma) that requires them to be off work for an extended duration, then they may need to hire a replacement with that skill set. Therefore, this Trauma Insurance policy can provide proceeds to be able to afford to replace the salary of a new hire.
Business owners also need general business insurances which depend on the industry, such as professional indemnity and public liability.
What Insurance do business owners need if they own their business premises through one or multiple SMSFs?
Commonly, business owners decide to buy business premises by pooling their super together. The type of insurance they need depends on the ownership structure of the property:
Unit Trust: Accountants & Advisers often recommend buying the property through a unit trust when there are three or more business owners. Then, each business owner will have their own individual SMSF which will own units in the unit trust. As there are multiple business owners:
o It is often ‘easier’ to be able to sell the units in their SMSF to the other owners if was required due to a Life Insurance or TPD event and;
o The business is more likely to remain operational, so the life insured could decide to retain their units as an income generating investment and;
o It is more likely each business owner could or should organise their own individual Life and TPD insurance policies.
Joint SMSF (with a corporate trustee): A joint SMSF is often set up when there are only two business owners involved. It is set up in this way because if it was set up under a unit trust, and one SMSF needed to be wound up, the other SMSF is generally not allowed to own more than 50% of the units as it would breach the ‘control’ test, and therefore, the property as a whole may need to be sold.
Therefore, when a property is bought in a joint SMSF, a cross-owned Life and TPD policy can be set up so that the policy owner can pay out the SMSF member balance of the departing member. Cross ownership means that if one director passes away or becomes TPD, the other director receives the insurance proceeds.
If you are a business owner who needs help:
The purpose of this blog is to provide general information only and the contents of this blog do not purport to provide personal financial advice. We strongly recommend that investors consult a financial adviser prior to making any investment decision. The contents of the our blog does not take into account the investment objectives, financial situation or particular needs of any person and should not be used as the basis for making any financial or other decisions. The information is selective and may not be complete or accurate for your particular purposes and should not be construed as a recommendation to invest in any particular product, investment or security. The information provided on this blog is given in good faith and is believed to be accurate at the time of compilation.
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