What is Buy/Sell insurance?

Buy/sell insurance is a mechanism that provides funds for remaining partners to purchase a business share from a departing co-owner, in the event of death, permanent disability or trauma. It means the remaining owners can quickly and efficiently acquire the departing owner's share and continue running the business with minimal disruption.

Buy/sell insurance benefits both the remaining owners and the departing owner.

For the remaining owners, it provides funds to transfer the business share to them, ensuring that the business is not placed at risk.

For the departing owner, or their estate, buy/sell insurance means that they receive funds to compensate them for transferring their business share — just as though they've 'sold' their share in the business.

Business succession planning

As a business owner, you know that your business isn't just about work — it's your life and your livelihood. Your share in the business is likely to be one of your most important assets that funds the lifestyle you and your family enjoy today — and will continue to enjoy into the future.

A business succession plan is vital to ensure your family is protected in the event you, or one of your business partners, become ill or injured and are unable to stay in the business.

A business succession plan has two key elements which include:

1. A funding mechanism that provides a source of finance to facilitate a transfer. Funding can be supplied by selling assets, taking out a loan, a gradual buy-out, insurance or a combination of these. Buy/sell insurance is commonly used to cover insurable trigger events such as death, permanent disablement or trauma and it is often a cost effective solution.

2. A legal agreement that specifies the terms and conditions of the transfer of a business share, including a suitable business valuation method and trigger events.

Types of insurance

There are three types of risks that can be covered by buy/sell insurance. You can take out cover for the death, total and permanent disablement (TPD) or critical illness (trauma) of a business partner.

As everyone's circumstances are different, you should speak to your financial adviser about what types of cover are suitable for your business, and how the insurance package should be structured.

Ownership of the policy

There are several options available when it comes to policy ownership, and your financial adviser can help you understand the right ownership for your situation.

  • Self-ownership — where the person insured is the policy owner. This is the simplest structure and the person insured keeps control of their own policy, even if they leave the business.
  • Cross-ownership - where the business owners take out insurance on each other. The policy ownership changes with changes in business ownership.
  • Insurance trust — where a trust owns the policies on behalf of all business owners. This means policy ownership is not affected by changes in business ownership.
  • Business entity (company or unit trust) — where the business or business trust owns the policies on the business owners' lives. Policy ownership is not affected by changes in business ownership, unless the person insured wants the policy assigned to them when they leave the business. The business uses the insurance proceeds to buy back the departing owner's (or their estate's) share.
  • Superannuation fund — where the superannuation trustee owns the insurance policies on the business owners through a super fund. The person insured has control of their own policy.

When considering ownership of an insurance policy, you need to consider control of the policy, payment of premiums, the business structure, the potential for ownership changes and tax on the receipt of insurance proceeds.

Your financial adviser, accountant and solicitor can advise you further on the implications of the various ownership options.

Tax considerations

The cost of the insurance cover you take out to fund a buy/sell agreement is generally not tax deductible. Capital gain tax (CGT) may also apply in some circumstances.

Your accountant or tax consultant can advise you further on the tax implications of buy/sell insurance.

Business valuation

An important part of a buy/sell agreement is the valuation of your business. Business valuation options include:

  • Market value at the date of the trigger point
  • Market value at the date of the agreement with indexation
  • An agreed industry formula
  • An agreed dollar amount, or
  • The engagement of an independent arbitrator.

It is important to ensure that the level of cover of your insurance policies keep pace with changes in the business value, so you don't get caught short if you need to effect your buy/sell agreement. You should also consider any capital gains tax that may apply when you receive the insurance proceeds and transfer the business share.

Your accountant can advise you on the valuation of your business and ownership share.

Transfer agreements

Death is generally an automatic trigger to transfer a business share. However, temporary incapacity or the suffering of a trauma incident may not be. The legal agreement would usually specify that the transfer of the business share should happen if the insured person is absent from the business for more than a certain period of time, or with a loss of turnover.

A transfer agreement is a legal document. Your solicitor can advise you of the appropriate legal agreement needed to transfer a business share.

You and your professional advisers

You don't need to make decisions about buy/sell insurance on your own. Designing an effective buy/sell insurance package requires your financial adviser, accountant and solicitor to work together. Each professional brings their own unique skill sets.

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