If the Proprietor will still own the Business or an Equity in the Business at the time of their death, then the Family needs to consider strategies that achieve the goals of the Family with respect to the Business after the Proprietor's death.

Because death is an Insurable Event, Insurance can be used to address some of these issues.

Buy/Sell or Equity Insurance is most relevant to Multiple Proprietor Businesses in which there are arms-length Proprietors or Owners.

However, it can also be relevant to Sole Proprietor and Family Businesses, if no spouse or child wishes to retain ownership of the Business.

It is particularly relevant where it is possible to identify a prospective Purchaser of the Business or Equity in the Business.

Identifying a Prospective Purchaser

If a Proprietor died suddenly, the Executor of their Estate would normally be responsible for determining whether the Business should be sold or wound up.

This would require them to search for a prospective Purchaser in the aftermath of the Proprietor's death, when a Purchaser could legitimately argue that the goodwill of the Business has declined significantly.

This concern can impact whether a Purchaser can be found and, if so, the Purchase Price they are prepared to pay.

If the Business is substantial and it is unlikely that a member of the Life Insured's family would like to take over active responsibility for the Business, it might be possible to identify a prospective Purchaser during the life of the Proprietor.

Alternative Purchasers

There are two primary alternative Purchasers for a Business owned by a Sole Proprietor:

the Management or Staff of the Business; and
a similar Business (or "Friendly Rival").

If these opportunities can be identified during the life of the Proprietor, there is scope to negotiate and document Buy/Sell strategies that will give certainty to the Proprietor and their Family.

Management (or Employee) Buy Out Strategy

Insurance can be used to enable some or all of the Management or Staff to acquire the Business for a Pre-agreed Purchase Price.

This option would allow the Purchasers to acquire ownership of the Business without needing to borrow the Purchase Price.

They would also guarantee their own employment after the death of the Proprietor.

On a case by case basis, it would be necessary to determine whether the Premium cost of the strategy should be borne by the Business or the prospective Purchasers.

Foundation for Retirement Strategy

An Insurance-funded Management Buy Out strategy can be the foundation for discussions with respect to an orderly sell down of Equity in the Business to Management or Staff during the lifetime of the Proprietor.

Use of Personal Cover for Future Buy/Sell Cover

If a Management Buy Out will eventually be an appropriate retirement strategy for the Proprietor, it is worth taking out Personal Insurance Cover equivalent to the value of the Equity in the Business.

This Cover can subsequently be used as Buy/Sell Cover when it is appropriate for the Management to acquire an Equity in the Business or be party to an Insurance-funded Buy/Sell Agreement.

For example, the original Proprietor might commence the strategy with 100% of the Equity and Personal Cover equivalent to 100% of the Purchase Price.

When an Insurance-funded Buy/Sell Agreement becomes appropriate, this Cover can be re-purposed as Buy/Sell Cover.

When the Proprietor actually sells down some Equity, the Business would have the same needs as a Multiple Proprietor Business.

If the Proprietor waited to sell down Equity before acquiring any Buy/Sell Cover, they might not be insurable at the time.

Thus, an Insurance-funded Management Buy Out strategy creates future flexibility.

Future Conversion of Buy/Sell Cover into Personal Cover

When the Proprietor actually sells down some Equity, the original Buy/Sell Cover can be re-purposed or re-allocated to other Needs.

Example

For example, if the Proprietor has insured the Purchase Price of 100% of their Equity and then sells 25% of the Equity, the split of the Cover can be changed, so that only 75% is used for Buy/Sell Cover and the balance can be allocated to another Need (such as Personal Cover or Debt Reduction Cover).

"Friendly Rival" Strategy

If there is no suitable Purchaser within the Management or Staff of the Business, insurance can be used to enable another Business in the same industry or profession (a "Friendly Rival") to acquire the Business for a Pre-agreed Purchase Price.

Whoever dies first knows that they will be able to sell their Business to an identifiable Purchaser for a Pre-agreed Purchase Price.

Whoever survives will know that they have been able to expand the size and critical mass of their Business at premium cost (i.e., without having to borrow the Purchase Price).

Again, an Insurance-funded Friendly Rival strategy can also be the foundation for discussions with respect to a merger or sale during the lifetime of the Proprietor.

Example

For example, the Proprietors of two Financial Services Businesses within the same Dealer Group could agree to purchase each other's Business upon the occurrence of an Insured Event.

Similarly, the strategy can apply to two franchisees in the same franchise operation or two pharmacies or news agencies in adjacent suburbs.

Estate Equalisation Strategies

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Adviser Tip

In the case of Retirement, a Complete Succession Plan can pre-agree the Purchase Price and specify a timeframe for payment.

If you do not have adequate insurance for an Insurable Event, your Succession Plan can specify a timeframe for payment of the shortfall.

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