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Business insurance - Editor’s Note – the Shape of Money stopped providing financial advice in April 07
For the owners and managers of the more than 250,000 small and medium sized New Zealand businesses, business insurance can be just another unwanted complexity and cost. While there are a number of different business insurances - including directors' liability and theft by employees - this newsletter will briefly review the insurances relating to death and disability, the options available to manage buy/sell agreements, the repayment of debt, and the loss of key people, as well as the issues of the sole trader.
Protecting the key people
An important issue is how the business will survive with the short-to-medium term absence of a key person. For example, you may have only one salesperson who knows, after 10 years, everything about your product and clients. The absence of that person from the business could seriously disrupt revenue generation.
Unfortunately, the overheads remain and suddenly a successful business is running empty on cash flow and in serious trouble. There are insurance products that can be purchased to help protect the business from such an event.
Protecting the shareholders
If an owner of a business dies, or is incapacitated, there should a plan to manage the orderly transfer of ownership when the estate of the owner is either incapable, or unwilling, to assume the responsibilities of the business and instead wants to sell their share of the business and move on.
In this common situation, it is wise to first have a buy/sell agreement in place which details the circumstances or events that trigger the buy/sell options. The agreement would also ideally detail the valuation methodology that is to determine the value of the shares.
The next important consideration is to determine how the funding for the purchase of the shares will be arranged. A common and cost-effective solution is to buy insurance (life, total and permanent disability and trauma) on the owners of the business.
This solution is also used to help repay any outstanding debt and to release the owner (and hence the estate) from any personal guarantees such as lease or rental costs.
Protecting the sole trader
The sole trader is also very exposed to their own short-to-medium term absence through disability. If they're not at work, clients will go elsewhere. When they recover and get back to work, the client base has gone and savings have been run down to pay for household groceries and rent on the business premises. Again, there are some useful insurance options to consider which cover this situation, including personal income protection, business overhead expenses, and locum cover.
What you should do next
If you thought your insurance broker or financial adviser wasn't too hot on personal insurance products, they are likely to be overwhelmed by the requirements of business insurance. A good business insurance adviser will, apart from having a strong knowledge of the solutions available in the marketplace, be able to interpret your needs through an evaluation of your financials, shareholder agreements, business valuations, and through discussions with your other advisers, including your accountant and lawyer.