Key person insurance would have covered the costs of contract penalty and business loan repayments.
Mary & William – start up entrepreneurs.
Mary and William are start-up entrepreneurs who recently launched a Water Purification business. They have a key employee – Joe who is an Industrial Chemist and has perfected a new method to purify water that has been polluted from mining. The business has just secured a large contract with a US based Multi-National mining Company to buy $2,000,000 worth of the Water Purification product developed by Joe. It will involve Joe working closely with the US Company.
They had a night out celebrating the new contract. Joe begins his 30-minute drive home and on the way he is involved in a horrific traffic accident and is tragically killed.
Following Joe’s death Mary & William are beginning to wonder how they can fulfil the contract. Although they are great entrepreneurs, they have no idea how the water purification process is produced.
They realise that without Joe it will be impossible to complete the order placed by the US customer by the agreed date. This will result in Mary & William having to pay a penalty as stipulated in the contract. The penalty is $500,000. They are also worried that without the $2,000,000 order they will not be able to meet their business loan repayments.
Mary & William are starting to realise how much the ongoing viability of their business is compromised by the absence of Joe.
KEY PERSON INSURANCE
Key Person Insurance is essentially life, total & permanent disablement (TPD) or Trauma insurance taken out by a business on the life of a key staff member. If the key staff member cannot perform their duties due to an insurable event the business can use the insurance proceeds to replace lost revenue, repay debt or cover the cost of recruiting a suitably qualified replacement.
For example, if Mary and William had taken out a life insurance policy on Joe, the insurance proceeds could be used to:
- Pay the $500,000 penalty
- Meet ongoing business expenses such as loan repayments
- Make an attractive remuneration offer to another suitably qualified Industrial Chemist
With advice, this business has ensured both partners and their families are compensated should something happen where one partner is unable to work.
Jeff and Brian – Partners in commercial construction.
Jeff is 48 and Brian is 50.
They have been in business together for 5 years. The business is trading very well and has expanded considerably since commencement. Jeff is the project manager over all business projects. Brian is responsible for securing new work and managing the financial side of the business. Jeff and Brian are married with children at school. Both have personal mortgage debt.
WHY ARE THEY SEEKING ADVICE?
Jeff and Brian are concerned that if something happened to either one of them e.g. death or inability to work, that they would each not have the funds to buy out the other’s 50% share of the business.
JEFF & BRIAN’S GOALS
Enable each partner to be able to buy out the other’s share of the business in the case of death or inability to work. They wish to be able to provide for their families’ long term financial security.
(HIGH LEVEL ONLY – DOES NOT DETAIL ALL STRATEGIES)
The strategy recommended is to create a business succession agreement that covers the situation where an owner may die or to not be able to work due to disability. This involves the implementation of insurances on each partner’s life to fund the other’s purchase of their share of the business, should one of
these events occur.
CURRENT ANNUAL TURNOVER
Recently been valued at $5,000,000 which includes goodwill and assets
Business has a 5 year history
Trading well and has good prospects
Value of Advice
The business now has a mechanism to ensure that any funding required to compensate a partner and his family if and when required.
- The surviving business owner receives full business ownership
- The deceased family is compensated for the value of his share in the business
If such an agreement is not in place it may lead to significant issues between all parties, ie
- The surviving partner may need to go into significant debt to buy out the other partner’s share
- The surviving partner may find himself in a difficult partnership with the surviving spouse of the deceased, that may not be best for the business.
The idea of starting your own business can be enticing but taking the right practical steps and planning ahead can help you make the most of any opportunity.
There’s a lot to think about when starting a business. You’ll have a better chance of achieving business success when you know what to expect and how to plan financially.
How we can help
If you’re thinking about starting a business, we can help you consider:
- The financial planning aspects relating your business plan
- How working for yourself will affect your super
- Any financial obligations that may apply if and when you exit your business.