By: Gerhardt Meyer CFP®, Head of Technical Support, PSG Wealth
Running a successful business takes a sizeable financial investment. However, many business owners fail to plan for what happens should they die, become disabled or lose one of their key employees because of these very reasons. If you are a business owner, estate planning becomes essential. Your business may be the only income your family has, and if you pass away, they may have to manage a business with no previous experience or possibly lose the business and its value. So, what should you consider?
As part of estate planning, business owners must ensure the continuation of their business, retaining its value, or that liquidating business assets are arranged in advance, and to the best advantage of any dependants.
The need for a buy-and-sell agreement
If you pass away without any plans in place, your ownership shares in a business will fall into your estate. This is the case even if your business partners would have preferred to buy out your shareholding or your family would have preferred to have the value of your shareholding paid to them.
If you don’t have a binding buy-and-sell agreement in place, your business and the financial well-being of your family can be at risk. Without a clear succession plan, disputes can arise among partners or their surviving spouses, leaving the future of your business as well as the financial freedom of your family at risk.
A buy-and-sell agreement is a legally binding agreement between shareholders that clearly stipulates what happens to shareholders’ interests in the unfortunate event of the death or disability of one of the shareholders. A suitable and relatively inexpensive method of funding the purchase price of a buy-and-sell agreement is through life assurance. Shareholders insure each other’s lives and the proceeds of the policies are to be used to fund the purchase price of a deceased shareholder’s shares. The family of the deceased will then receive the full value of the deceased’s interest in the business as soon as the estate is wound up. Likewise, no hardship is caused to the co-owners of the business as they can continue to trade without having to find the funds to buy the deceased’s interest or have unskilled family members interfering in the running of the business.
The buy-and-sell agreement may also provide for a sale of shares upon the permanent disability of a shareholder or provide for the purchase of loan accounts that are due by the company to the deceased shareholder.
Contingent liability insurance
Most business owners have to sign surety for a business debt at some point. While this reality is something business owners must live with, it is risky to sign surety without contingent liability insurance. At worst, it can place your personal estate at the mercy of creditors, leaving little, if anything, for your family to inherit.
Most surety contracts bind a business owner as a co-principal debtor. This means that the creditors can choose from whom they want to claim repayment of the loan. Should a co-principal debtor pass away, the creditors can claim from their estate. In the winding up of the estate, all creditors must be paid first, which means the business owner’s heirs only receive what is left after all claims and taxes have been paid. If this is the case and there isn’t enough cash in your estate to repay creditors, your assets (including your family home) may have to be sold by the executor. Having contingent liability cover in place ensures that creditors will be paid from the proceeds of the insurance policy, eliminating the risk to your personal estate.
Key person insurance
You must also consider the possible loss of key people in your business – this can be you, your business partners or an employee. A key person of the business is one whose skills or knowledge are critical to the success of the business. Should a key person die or become disabled, this can cause a great loss to your business. This risk can be addressed by key person insurance. The proceeds of the policy may be used to absorb any disruptions to the company, protect credit facilities, and provide funds for the recruitment or training of a replacement.
Don’t fail to plan
Your business is your legacy and it is essential to consider all risks to avoid unintended consequences for those left behind. A qualified financial adviser can help you draft a financial plan that incorporates both your business and estate planning needs, providing you with peace of mind that your business legacy as well as family needs are adequately looked after.