Tips from Business Insurance Experts on Buy-Sell Insurance

“We want to find a simple solution to a problem that business owners have, whether that be through insurance, some other funding mechanism, self-insurance, or a combination of these.”

Bernard Maughan and Paul Stafford are Life Insurance Specialists, advising clients in the areas of Business Risk Insurance and Personal Risk Insurance. Paul (Melbourne) co-founded QA Insurance in 2018, with Bernard (Brisbane) joining the practice the following year. QA Insurance recruited Clint Hindle in 2021 to add to their team's expertise and capabilities.

QA Insurance Pty Ltd was licensed by the Australian Securities and Investments Commisson (ASIC) under Australian Financial Service Licence (AFSL) #542245 in 2022.

Bernard and Paul have been in the industry for 35 and 42 years respectively and have both spent an extensive amount of time in the Business Insurance space, contributing to a unique set of skills and experience within their team on the East Coast of Australia. Clint has been in the insurance industry for over 10 years and is an accredited life insurance underwriter.

Combining years of experience with intimate knowledge of underwriting issues, business valuation and the practical aspects of Business Succession and Key Person risks, the principals of QA Insurance work closely with clients to uncover their needs and provide practical funding solutions for them.

In this article, Bernard and Paul discuss the following key points and their tips based on their Business Insurance experience:

1.       Who do we work with?

2.       Uncovering Needs

3.       Business Valuation

4.       Adjusting for Capital Gains Tax and other imposts

5.       Funding Options (Do you even need Insurance?)

1.     Who do we work with?

As we work with General Insurance brokers, we often get asked to contact a client who needs life insurance, and often when we talk to the client, we learn that he or she owns and runs a business. This can be any type of business, including:

• Sole Traders

• Individuals who operate as a company, with one director and one or two shareholders

• Family businesses that operate through a Trust

• Companies with multiple directors and shareholders, and of course

• Partnerships, whether between individuals or, more commonly, between the entities that they own or control.
  

There is a common misconception that Business Insurance is only applicable to Partnerships and Companies. However, the risks are the same for all business owners, and the following questions need to be asked:

• What happens to your business if you are not here permanently?

• Would it be able to complete the work that is outstanding?

• Would it be able to repay its debts and meet other financial liabilities?

• Would you like your family (heirs) to be able to receive the value of the business you’re building?

Asking this of a Sole Trader or a single director family company may raise an eyebrow, but the questions are relevant, given that:

a)       The individual may be contractually obligated to provide a piece of work, and may be sued for non-performance

b)      A person’s debts don’t die with them, and if a sole proprietor has a line of credit or other loan facility, it will create a liability in the estate. Remember, creditors get paid first.

c)       Even a Sole Trader operating under a Trading Name, or a Single Director Company can sell their business/client list, ongoing revenue etc., and it may require someone to manage the business until such time as it’s sold or wound up. The family may or may not be involved in the running of the business, and in a time of grief and bereavement, are most likely to not consider the financial aspects of the business until it’s too late.

Of course, where there are multiple owners, the idea of business insurance seems more logical, but many advisers overlook the business insurance needs of businesses with more than 2 directors and shareholders, as they’ve been conditioned to think of business insurance in the sense of business succession planning between two partners in a business.

We see business insurance needs for anyone who:

• Would like the business to be managed well, and clients and customers taken care of after their demise

• Would like their share of the value of the business returned to their family or heirs.

• Does not want their families or their estate encumbered by the debts and liabilities of the business

• Wants to redistribute ownership and secure the value of a business in the event of another owner’s unplanned exit

• Wants to ensure that owners are looked after in the event of a temporary absence from the business due to illness or injury
  

You can see from this, that we consider anyone who owns and/or operates a business, as needing business insurance. The next step in the process is to engage the client and help them understand what their needs are.

2.     Uncovering Needs

Once we’ve been through an initial discussion and can get the business owners to meet with us to review and assess their business risks, we discuss and show the client our process which we have colour-coded, and present our findings in a table that is very clear for all involved.

We use this table to workshop with the owners and draw out from them the Business’s Assets, Liabilities, and the individual(s)’ Personal Assets, Liabilities and income needs. Using the table, we identify the needs as a funding purpose, and earmark the recipients and any notes as to the purpose or how the quantum has been reached.

The Assets will always include the Pre-Agreed Sale Price or Equity, CGT on pre agreed price, Stamp Duty, Legal & Accounting Fees, and a provision for future growth in the value of the business.

Liabilities will always include Bank debt, leases & other Liabilities, Director’s Loan Accounts, Key Person Income, and Key Person Capital.

Finally, Personal Assets & Liabilities include Home Loan, Equity Loan & other liabilities, and Living Expenses.

"We see Business Insurance as an opportunity to help any client who has ownership or equity in a business to understand how to plan for and execute the transfer of ownershipto the other party, and the embedded value of their business to their family, heirs, or successors in an orderly fashion."

3.     Business Valuation

When we workshop our way through this with clients, one of the biggest challenges is that many owners don’t know what their business is worth, and we must guide them through the various methods of calculating the value.

We often work with their accountants to present a business valuation, but just as often, we role play with the owners, getting them to sit with a buyer’s and a seller’s hat on to understand the business’s market value. At times, we will ask one of the owners to leave the room, and ask the other owner, “Now your business partner/co-owner isn’t here, what do you want if he never comes back?” This can quickly crystalise an agreed value for the asset.

4.     Capital Gains Tax (and other imposts)

While it takes some skill and considerable patience to coax a credible and agreed-upon valuation out of the owners and/or their accountants, we have to stress that the purpose of doing so, is in order to calculate the price for DISPOSAL of the asset. Capital Gains Tax needs to be calculated, and factored into the equation, if the clients wish to have the full value of their share of the business returned to their families or estate, or heirs. Then, we add Stamp Duty, Legal and Accounting Costs. The sum of the Valuation plus all of these costs provides the amount that needs to be funded.

5.     Funding Options (Do you even need Insurance?)

By presenting the Colour-coded table in this way, business owners and those with vested interests can quickly see what the real value of the business is, and the costs that will be incurred in crystalising the asset value when there is an unplanned exit of the owners. When confronted by a lower value or even a debt which they (their estates or families) will have to bear, they quickly turn their minds to how to mitigate the situation. This is where we open the discussion about the various funding strategies they can consider.

We present various strategies to clients and highlight the pros and cons of each to the clients. They may include:

• Self-funding

• Vendor Funding

• Bank or Personal Loans

• Life Insurance policies
  

In this way, we facilitate a discussion about the future likelihood or certainty of each funding solution, the cost to both parties and whether this is a solution that works for them. Often, we find that there is a disparity in the ages and/or health of the parties, which can result in a blended strategy being the most appropriate. Sometimes insurance isn’t the only answer, but it provides 3 benefits that everyone understands and desires:

1. Once a policy is in force, the payment of a benefit is certain

2. It usually costs cents on the dollar and can be funded in instalments

3. Backed with an enforceable legal contract (Buy-Sell Agreement), it ensures that exactly the right assets end up in exactly the right hands, at exactly the right time.

Knowledge is power

We see Business Insurance as an opportunity to help any client who has ownership or equity in a business to understand how to plan for and execute the transfer of ownership, and the embedded value of their business to their family, heirs, or successors in an orderly fashion.

We do this by working closely with the owners and their legal and accounting professionals to understand, and drill down into the aspects of the business that contribute or take away from its value. We then highlight and account for the costs of disposing of the asset, and any future growth in the value of the business, and provide this information back to them, while facilitating a necessary discussion around funding strategies.

This always leads to satisfied clients, who are more than willing to consider insurance as a funding strategy, and who understand the relative merits of the decisions they need to make. Knowledge is power, and we find that clients who are “in the know” appreciate advisers who provide them with the power to make informed choices.

About the Authors

Bernard Maughan: “I started working for an insurance company as a Graduate Management Trainee in 1988 and have been involved in various aspects of the Life Insurance industry ever since, including Regional Sales Manager, National Training Manager, & National Compliance Manager for a well-known Australian insurer, National Insurance Manager for one of Australia’s largest dealer groups at the time, and CEO of a Singapore Financial Planning company. I’ve also been a holistic financial planner, in both Australia and Singapore, before turning my focus back to specialist insurance advice, and I joined QA Insurance in February 2019.”

linkedin.com/in/bernardmaughan

Paul Stafford: “At the age of 21, I started with AMP in 1970 as an insurance agent (collector agent) in Melbourne. I was the youngest agent appointed in Australia at that time. I was transferred to Warrnambool as an Agency Manager and stayed there from 1973 -74 before being transferred back to Melbourne’s western suburbs. I left the industry in 1978 and moved to Warrnambool and ran a 7 day a week entertainment business. I returned to the industry in 1988 and was a founding partner in Silvan Ridge Financial Services in Warrnambool and stayed in the partnership until 2008. I then set up a Succession Planning Business and moved to Melbourne to take advantage of the broader opportunities in the city. In 2012 we formed Think Insurance, licensed through Marsh Advantage Insurance , and created QA Insurance in 2018 which continues today.”

linkedin.com/in/paulstafford

Disclaimer:

This information has been prepared for educational purposes only. It does not constitute legal or tax advice, or financial product advice tand is general in nature. The material assumes a certain level of existing knowledge about the topics discussed, and familiarity with the obligations of business owners. No person’s financial situation, objectives and needs were taken into account in preparing this material. To the extent that any financial products are discussed in this article, you should always consider the relevant Product Disclosure Statement(s) prior to deciding to acquire or continue to hold those products. While care has been taken in the preparation of this material, QA Insurance Pty Ltd does not warrant its accuracy or completeness. The information is not an exhaustive guide, and it may also fall out of date. No user of this information should act or fail to act based on this information, and QA Insurance Pty Ltd expressly disclaims liability of any kind in respect of anything done or not done in reliance, whether in whole or in part, on this material.