It sounds like the set up for a joke: There are these two lawyers in practice, who have worked together for years. Their client base is solid and business is good.
Only it’s not a joke. Worse, it’s a true story.
What happens next is this: one of the partners has a stroke, which paralyses him down one side. He needs his income to live on, and the practice can’t afford the search fees to replace him. So after he comes out of hospital, he goes back to work. Only, this time he has a nurse in tow plus an assistant to turn pages for him. The practice sinks, partly because of the extra staff, and partly because he can’t work at full capacity any more.
Foresight would not have prevented the stroke, but the partners could have avoided the fallout, if they’d taken out the right insurance.
Unfortunately, most businesses aren’t covered for such contingencies.
Most people realise they need workers’ compensation, professional indemnity and public liability insurance. But a key cover that’s often overlooked is income protection and its associated insurances.
“What’s your most valuable asset?” asks Marc Fabris, Strategic Marketing Manager, Life Risk, for Zurich. “Your ability to earn an income.”
He says that 70% of traumatic events occur outside the workplace, which means they’re not funded by workers’ compensation. That means you need some kind of trauma and disability insurance to protect your income in case of temporary or permanent disability. Insurance can also cover the cost of modifying your home, if you wind up permanently disabled.
“You might find the cost to protect your income isn’t much different to the cost of protecting your car,” says Fabris. “And it’s tax deductible.”
Protect your business
Most businesses have ongoing operating costs, from commercial leases to wages. How will you fund them if you’re off work for any significant time? The answer is business expenses insurance. Chris Sharpe, Technical Business Development Manager for PrefSure says that it’s a cover that’s usually overlooked.
“A business expenses policy will cover up to 12 months’ expenses,” he says, listing things like the cost of a locum and other staff salaries, as well as rent, utilities and loan interest payments.
Likewise, if you have taken out any sort of loans for your business, make sure you’ve covered by loan protection.
Key Person insurance
The loss of one or more of your business principals, even for a short time, can devastate a business. For a start, there’s the cost of replacing that person, not to mention the loss of their expertise. Key Person insurance can lock in the value of the business principals.
Sharpe says that, depending on how a partnership is structured, Key Person can be taken out either for capital or revenue purposes.
“Capital purposes relates to cover for any debt,” he says. If the company has borrowed to buy premises, for example, and something happens to one partner, Key Person insurance can provide the capital needed to repay the loan.”
Key Person can also give you the cash flow you need to keep going until that person returns to the business, or you replace them. You will need to see a tax lawyer to minute the insurance, or you may have to pay significant tax on the payout. Death, Disability and Trauma insurances can be bundled into Key Person insurance, and can be tax deductible in some circumstances.
It’s not enough that you protect your practice from the loss of the key person. What would you do if their family insisted you liquidate the business, so they could get their rightful share of the partner’s estate? Would a surviving spouse insist on moving into the business and take over their partner’s role?
These are tough questions. But the time to sort out the answers is before the worst happens, which is where ‘Buy/Sell’ agreements come in. A Buy/Sell is a contract stipulating what will happen to a practice in the event of the death, incapacitation, retirement or disappearance of one of the partners. Buy/Sells are usually funded by an insurance policy, to give the surviving partner the money to buy out the other partner’s interest in the business. So where Key Person protects the value of a business when something happens to a principal, Buy/Sell is about the effective transfer or disposal of ownership.
Before you can organise a Buy/Sell, you need to know the true value of your business. You also need to understand how your business is structured. You may believe you’re the owner of your business—but your accountant may have structured your business so that a family trust owns it. This could mean the family trust should own the insurance.
“If you don’t understand the structure of the business,” says Chris Kirby, Head of Life Risk at Zurich, “then it can cause a whole heap of ramifications.”
One is that the family trust may end up carrying the business’ debt.
“We recommend you should review your business succession arrangements annually,” says Fabris. “You can set up an agreement and incur a significant tax liability initially if you don’t do it right.”
You can set up these agreements so that there are different mandatories for different situations. A Buy/Sell agreement is an essential part of business succession planning and has legal, taxation and financial implications. (The three types of agreements are outlined below.)
Kirby notes that Buy/Sell agreements don’t just ensure the orderly transition of the business, but also protect the families of the people involved. “In the event of a significant disruption to a business, a potential buyer will believe they can probably purchase the business at a greatly reduced price,” he says. “It won’t reflect the true value of the business, which the estate of the deceased may well have to accept.”
All these insurances sounds daunting, but they can often be bundled together to bring the overall cost down. “A broad statement to make is that generally you can fund all of these insurances with a rough guide of about one to two per cent of the total exposure,” says Kirby.
Insurance in action
Orhopaedic surgeon Dr Michael Holt is one person who understands the value of insurance. After being hit by a car, Holt suffered a skull fracture and spinal fractures, and sight and hearing loss. It seemed he could never return to practicing surgery.
“After my accident, no-one really knew what to do with me,” he says. “There’s no real occupational therapy programme for microsurgeons and nobody knew how to advise me.”
Holt whiled away his enforced retirement with building projects. He built his kids a cubby house, added an irrigation system to his property and completed a house renovation. In the process, Holt found he was combining high-level problem solving skills with physical work. The unexpected benefit was a level of rehabilitation that no-one could have foreseen. Now he’s back in theatre once again.
Holt claims it’s all due to the insurance salesmen who sold him income protection, business expenses and trauma insurance soon after he went into private practice.
“If I had had inadequate insurance cover I probably would have lost my house, have lost my car—and that would have been a tragedy—and I may have ended up divorced,” he says. “But the fact I had the money to do silly projects helped me rehabilitate.”
Holt now tells everyone within earshot that they can’t afford to live without insurance.
“If that guy hadn’t sat in my office and got in my face, I wouldn’t have got around to it in time,” he says. “I worship the ground that man walks on.”
How to keep your business safe
- Keep your business valuation up to date.
- Get expert advice on insurance. Typically, your financial adviser will be the person to turn to; however, Key Person and Buy/Sell agreements are specialist insurances that demand an expertise your financial planner may not have. If so, simply ask him or her to refer you to someone who can help.
- Buy your insurance in a bundle.
- Get a tax lawyer to minute your insurance. Your financial planner may be able to coordinate this.
The three types of Buy/Sell arrangements:
- A mandatory Buy/Sell. When a trigger event happens – such as a partner dies or becomes disabled – a buy out or sell out happens automatically. To allow the Buy/Sell to occur smoothly, you must know the value of your business.
- A mandatory Put/Call. This allows one partner to decide what happens to the business in the event of a trigger. The benefit here is that the family or estate of the deceased cannot dictate the fate of your business.
- A non-mandatory Put/Call. Here, both partners must agree on what happens after a trigger. This means one partner cannot throw another out of the business in the event of trauma.