A survey1 of Australian small businesses revealed a high percentage have inadequate business insurance. Although most business owners don’t hesitate to insure physical assets such as stock, equipment and premises, many aren’t insuring themselves or other key people in the business for illness, disability or death.
The survey also showed only 10% of small businesses had a documented succession plan and 46% had given no thought to succession. Unfortunately, the consequences of not protecting key people involved in a business can be dire, often resulting in the demise of an otherwise viable business.
If an owner or key person is unable to work through illness or injury, it doesn’t take long for the business to be affected. The absence of that key person can put pressure on the rest of the team to pick up the slack or employ extra staff. The flow-on effects can include slower production, rising costs, or reduced revenue. Left unchecked, a cashflow crisis can erupt as profits reduce, and the business struggles to pay creditors.
Three levels of protection
To protect a business against these risks, there are three basic protection needs that should be covered.
Asset protection insurance helps maintain cashflow, credit standing and assets if a key person in the business is out of action. It can provide money needed to repay debts to banks or other creditors. It’s called asset protection because if you don’t protect your debts, your assets will more than likely be at risk, as they’re usually financed by a loan or credit facility and held as security for that loan.
Most businesses have one or more key people whose skill, knowledge, experience and leadership generate significant revenue. If they were unable to work, the business could suffer a drop in revenue, or incur costs to find and train a successor.
Revenue protection provides a lump sum to compensate for the loss of revenue caused by the absence of that key person. It also buys the business time to adjust and keeps it alive as a going concern. If a new person needs to be employed, the insurance can provide funds to finance the recruitment process.
If one of the owners of a business dies or has to exit the business because of illness, the continuing owners might struggle to negotiate and fund a buy-out of the exiting partner’s equity. This is often complicated by dealing with heirs or legal representatives of the estate, whose priorities may not include the ongoing value or viability of the business.
Ownership protection insurance, coupled with a legal buy-out agreement, provides the continuing owners with the legal right of purchase at a predetermined price. It can also help fund the purchase of the exiting owner’s equity. The exiting party has peace of mind they, or their family, are going to get fair value for their business if they die, or are unable to work due to illness or disablement.
The continuing parties benefit too. They can maintain control of the business without having to raise additional capital to take on more debt or be forced to hastily bring in new business partners.
To find out how you can look after your business, speak with your financial planner. If your business is starting out, they can undertake a business needs analysis and develop advice customised to your business. They’ll also be able to make sure, as your circumstances change over time, your insurance keeps up with what you need.
1Cameron Research Group, The Australian Small Business Market for Financial Services: 2008.
Source: MLC Financial Focus Winter 2011