By Motshabi Nomvethe, Head of Technical Marketing at PPS
Small, medium and micro-sized enterprises (SMMEs) in South Africa are important drivers of economic growth. Data on turnover from the 2019 Annual Financial Statistics survey released by Statistics South Africa shows that small businesses, in particular, have made inroads in South Africa’s formal businesses sector.
According to the Centre for Development and Enterprise, The Small Business Report of June 2021, 68 494 small businesses are in the formal sector. These are mostly owned by one or two directors. This means that the director is also the shareholder of the business, and the start-up, in many cases, is funded by individuals who invest in the company and receive company shares in exchange.
If a business owner lends an amount to the business, be it a capital injection to purchase assets or remuneration accrued but not withdrawn, the business is indebted to such a business owner.
Therefore, the business will be liable to repay the loan when the owner passes away. As an alternative to including the loan account in a buy-and-sell agreement, the business could fund the loan amount through insurance to ensure funds are available to settle the loan account in the event of a death, disability or critical illness.
In this case, the business can take out a policy on the life of the owner who has a sizeable loan account in the business to cover the amount owed to this owner. On the death, disability or critical illness of such an owner, the business will use the proceeds of the policy benefit to pay the owner (or his estate), settling the debt. The policy is known as Credit Loan Account cover.
The key to understanding Credit Loan Account cover lies in knowing what will happen to a business when the owner to whom the business is indebted passes away:
- The loan account owed to the owner is an asset in his/her estate, and the executor will call for settlement of the loan.
- Consequently, the business will be expected to settle the loan.
- If the business cannot settle the loan, the executor can take legal action against the business to collect the debt.
With Credit Loan Account cover, the company will experience the following benefits:
- A cash injection to the business to settle the debt owed to the owner.
- The loan account will be settled, ensuring that the owner (or their estate) receives the funds they invested in the business, reducing the business’ liabilities.
- There will not be a claim against the business from the owner or their estate.
- Where the loan was subject to terms (for example, interest), with the settlement, the business will effectively increase cash flow and reduce future financing costs.
The risk of having to wind up a business due to the remaining owner having to settle the debt to the business by the deceased owner is more significant than having cover in place as it can result in the business closing and impact the livelihood of employees.