Buy Sell Insurance

Buy/Sell Insurance is a form of key person insurance designed to protect the ownership interests of a business where a partnership or multiple owners exist.

Generally set up by a solicitor, it helps provide funds so the surviving business owner can purchase the shares of the outgoing business owner, who cannot continue on in the business due to critical illness, total and permanent disablement or death.

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no-1How does it work?

A Buy and Sell Agreement allows for the surviving business owner to buy the business shares of their partner without having to provide the funds themselves, with the funds from the insurance policy covering the cost.

This hopefully provides a seamless transition of business ownership.

Without an appropriate agreement in place, either the surviving business owner would need to fund the purchase of the shares themselves or will be partnered in a business with the previous business owners family or estate.

While Revenue Protection which protects for loss of revenue and Capital Protection which helps cover outstanding business loans are generally owned by the business, Buy/Sell agreements are generally owned individually by the partners in the business.

no-2How much cover do I need?

Working out the level of cover needed can be difficult and an independent valuation of the business is generally the best way to find out what the business is worth.

If this is not possible, the business owner, accountant or an adviser can do the valuation – however the methodology must be shown.

When conducting the valuation it is vital to understand:

  • The nature of the business and how it generates revenue
  • The structure of the business, including all owners
  • Any partnership or share agreements in place
  • The value of good will, if any

You may be required to provide business profit and loss statements and balance sheets for several years in order to get an accurate valuation.

no-3What types of cover are available?

Like other forms of Keyman Insurance Buy/Sell insurance can be taken out with the following cover:

  • Life
  • Trauma
  • TPD.

Unlike life insurance and TPD Insurance, if a person makes a claim on a trauma policy due to a critical illness, there may be potential for that person to return to work at some point. Therefore a number of considerations need to be made when entering into a Buy/Sell agreement with trauma cover.

Any agreement will generally need to stipulate the criteria for a business owner to leave the business if they suffer from a critical illness.

no-4Policy Ownership:

There are a number of options when it comes to Policy Ownership:

Individual Ownership

Each business owner owns their own policy

Cross Ownership

Each business owner owns the insurance policy of the other business owners

Trust Ownership

A trust owns the policies of the business owners

Superannuation

The policy is owned by a superannuation fund

no-5Tax

Generally as a buy/sell agreement does not protect against the loss of revenue, the premiums are not tax deductible. However any benefit paid out is generally not tax assessable.

Cross-ownership:

If a cross ownership structure is decided upon, you need to be aware of the possible implications, especially if there is a vast difference in the age and health of the business owners.

A cross ownership structure means you are the policy owner and your business owner is the life insured, with the premiums being paid by you personally.

As the age and health status can differ between the two business owners, the premiums could be very difficult.

Two options to consider are:

Salary Increase

You could choose to increase the salary of the business owner who has to pay the higher premiums, essentially off setting the increased salary with the increased premiums.

Share the cost

You may want to split the cost of the premiums equally between the owners.

Published: March 25, 2015
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