Business Ownership Protection Insurance

What is business ownership protection insurance?

Business ownership protection insurance aims to protect the owners of a business in the event that one of its key people suffers an unexpected event such as death, disablement or trauma. 

In contrast to business asset and revenue protection insurance, business ownership protection insurance aims to protect the business by providing funds in the event that one of its key people suffers an unexpected event.

Business ownership protection involves two separate, but related components: the establishment of an exit (buy/sell) agreement and a funding arrangement.

Business ownership protection insurance provides financial resources for buy/sell and funding agreements in the event of the death or disability of a business principal.

Business ownership protection insurance can provide business owners with enough cash so that the remaining principal(s) can:

• Fund a buy/sell agreement documenting an agreed price or valuation methodology.
• Guarantee the orderly, equitable and certain transfer of ownership of the business.
• Maintain control of the business.
• Protect their entitlement to profits and the value of the business.
• Ensure all owners receive a fair value for their interest.

What is a buy/sell agreement?

A buy/sell agreement is sometimes called a ‘business will’ or a ‘critical events agreement’.  It provides a framework detailing the rights of each party should an event ‘trigger’ the operation of the agreement (eg the death or incapacity of a principal).

A buy/sell agreement should include:

• The names of the parties to the agreement.
• The events that will ‘trigger’ the agreement.
• The valuation method to be used to value each owner’s share of the business.
• How the remaining business owners will fund the purchase of the existing business owner’s share of the business.

Other methods to fund buy/sell agreements

If you do not purchase insurance to protect against the death or incapacity of an owner of the business, there are a number of other methods to fund buy/sell agreements, including:

• Selling a share of the business. But who to?
• Obtaining additional capital from the remaining business owners or a new business partner.
• Obtaining additional funding from a lender.
• Covering any potential losses from reserves or future years’ profits.

Selling a share of the business or obtaining additional capital from existing or new business owners may be problematic for a business that has just suffered the loss of an owner, due to the perception of additional risk.  Lenders may be reluctant to extend further credit for the same reason.

Therefore most buy/sell agreements are funded through life insurance products - that is life, total and permanent disability (TPD) and critical illness insurance.

Are buy/sell agreements still relevant if they are not insurance funded?

It is still advisable to have a buy/sell agreement in situations where you decide not to take out insurance or where a particular person may be uninsurable.  This is because the buy/sell agreement will provide the mechanism for dealing with the business ownership on an involuntary exit.  In such cases the funding of the disposal may be undertaken using the vendor finance mechanism or some other process pre-agreed by the parties.  Importantly, there is a binding document with a set of rules as to how the exit is to occur.