Business Insurances that you need to consider as part of an Acquisition or Exit

May 5, 2011

This topic has been coming up a lot in the past month, so I’ve decided to add an entry here to stop having to “pull out the record and play it again”.

Buy/Sell Insurance for Small Businesses

There are over 2,000,000 small businesses in Australia, employing nearly 5,000,000 people.

Buy/sell insurance supported by a well-written shareholders agreement can protect the owners of these businesses and their respective estates from the impact of death, disability and critical illness.

Life insurance can be chosen as the funding medium for an owner leaving a business due to death, total and permanent disability (TPD) or critical illness.

Death (as well as terminal illness) and TPD are clearly events that lead to the departure of an owner/shareholder from a business resulting in a need to transfer his/her business interest to the continuing owner(s).

In that case, it is vital for Directors/Shareholders to enter into a written buy/sell agreement so they can set out their respective obligations regarding the transfer of their equity of the business. Plus, the choice of insurance solution for buy/sell purposes depends on the trigger events being covered.

Level of cover for buy/sell insurance

The sum insured should generally be the value of each owner’s share of the business, updated at least on an annual basis.

For example, if the business consists of two shareholders/owners with an equal share of a business valued at $1 million, the sum insured on the life of each business owner should be $500,000 for the express purpose of buying the deceased/incapacitated owners share (that is, they need the insurance to cover other things like their dependents).

The insurance trigger events should be death and TPD and possibly some well-defined types of trauma. 

Valuation of buy/sell insurance

Given that the Australian Taxation Office will most likely deem that the disposal of a business interest under a buy/sell agreement occurs at market value, it may be prudent to use current market value as the preferred valuation method.

This value would need to be updated on a regular basis (i.e. at least annually).

An alternative would be for the business principals to use a particular formula, reflecting either an industry standard or a method appropriate to that specific business. In this case, it would be prudent for the owners to recalculate the value using the formula, and then subjectively determine whether the outcome is realistic and acceptable. It is worthwhile having the business’ accountant review the valuation and confirm that it is justifiable on ordinary commercial terms, which – depending on the sums insured – may also be an underwriting requirement. 

CGT Considerations

Please talk with your accountant and/or tax lawyer about the Capital Gains implications, to get some understanding of whether CGT liabilities should be incorporated into the buy/sell cover sum insured.

Policy ownership considerations for buy/sell insurance

Certain ownership structures have tax implications depending on the type of structure chosen for buy/sell insurance cover. In any case, it is important for business owners to seek advice that is appropriate to their individual situation and objectives. Regardless of the circumstances, the implementation of a buy/sell agreement is vital. The most common types of structures are as follows:

  • Self ownership – Each business owner owns his or her policy.
  • Cross ownership – Each business owner owns an insurance policy on the life of each of the other owners.
  • Trust ownership – An independent trustee of an insurance trust (also known as a bare trust) owns the policies on behalf of the insured (indirect self-ownership).
  • Superannuation fund trustee ownership – A super fund trustee can own the policies on behalf of the insured.

Buy/sell insurance provides vital protection for small business owners against the impact of death, disability and critical illness. You should be mindful of the important areas of buy/sell cover, including the choice of risk products, the level of cover, business valuations, policy ownership structures and their tax implications.

I highly recommend one of the leading players in personal and business insurance – Risk & Business Consulting (www.riskandbusiness.com.au) – to guide you through the specifics of what you need for this complex but vital area of protecting your business interests.

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Leadership, Should I Decide with My Head or My Gut?

February 22, 2011

Many years ago, when I was younger and less experienced in business management, I was chatting with the MD of the company I worked for.

We were discussing risk management, as I’m a PMP certified Project/Program Manager and have been for over a decade.

We talked about Risk Management frameworks, and for him it all boiled down to his “gut” in terms of whether the risk seemed acceptable or not.

Now don’t get me wrong, he didn’t just make all decisions based on his “gut” – but it certainly did drive him in terms of requiring more/less validation before making the final decision.

At the time I thought, there must be a better way than just “gut” for determining this sort of thing.

Now, years later, I tend to agree with him. Your gut-reaction to a decision definitely gives you a sense of comfort or foreboding about a decision and its consequences.

So, this leads to the topic of Leadership and the soft-skills associated with being a good leader. Read on for further details.

What is Intuition ?

In simple terms, intuition is when we know something or know what to do without necessarily knowing why.

What to do just comes to us in a flash of insight. Some intuition is instinctive. For instance, if someone starts running after you with an axe, you will most likely have the instinctive (and intuitive) response of either defending yourself or running away. Moreover, your reaction would be entirely rational.

Other intuition is the result of years of training and knowledge building. Police officers, firefighters, military commanders, emergency medical care providers, airline pilots and many others spend years in learning and honing their skills in order to react in an instant with the optimal solution.

Intuition …. So What ?

Our society expects specialists like those I’ve covered above to make high quality intuitive decisions quickly and accurately and then execute them effectively.

A surgeon with many years’ experience in the operating room has much better intuition than a newly-graduated doctor. The same goes for a highly experienced fireman.

In his bestseller Blink, Malcolm Gladwell describes how a veteran firefighter was able to “sense” a change in situation and order all of his crew out of a house just before it collapsed. He was unable to identify the steps in his decision; he just “knew” that it was time to get out.

The same goes for experienced leaders and executives in all walks of life. With many years of life experience, they can just tell if someone “has it” or doesn’t, and no amount of rational deliberation with convince them otherwise.

However, not all intuitive decisions are equal; and in fact some are wrong – or very wrong.

Experience, and in particular depth of experience, is a reliable indicator for a “good” outcome. Conversely, some situations are so novel, that intuition is next to useless and can even be counterproductive. In that case, deliberate decision making is needed in order to think through the factors impinging on the decision and to ensure that a variety of courses of action are considered.

The key here for a business leader is to consciously know whether they have direct or empirical evidence of an intuitive recommendation being “good”. If the answer is YES – follow your intuition; if the answer is NO – you will to take a more deliberate (and deliberative) and therefore rational approach.

Intuition versus Deliberation

As a guide, the following situations lend themselves to intuitive responses because of immediacy:

  • During an emergency, that requires an immediate response in order to save lives;
  • When there are direct threats to physical safety;
  • When a team has gotten lazy or overly reactive in the face of risk, and requires inspirational leadership to fix the situation.

There are situations where both Intuition and Deliberation are suited:

  • When you’ve been made an offer for the sale of your business;
  • When you’re considering “dropping” an existing client;
  • When you need to take action to correct the behaviour of a team/staff member;
  • When you’re considering a merger with another business;
  • When you’re considering taking on another business partner;
  • When you’re considering Product/Service extensions to your business.

Most other situations have enough time built in to them to allow at least some level of deliberation. It is prudent to involve outside experts and to form an advisory team when faced with unusual situations that will require imagination and resolve to turn around.

Finally, intuition does play a role in deliberate decision making because of its ability to generate deeper insights and provide innovative solutions.


The Second Biggest Issue Facing Your Business

July 16, 2010

It is commonly agreed that business cashflow, and the maintaining/growing of it, is the biggest issue your business will face day-after-day and year-on-year.  The challenges associated with sustainable growth and customer retention should not be underestimated no matter how successful you’ve been and for how long you’ve been in business.

Second to business cashflow as the issue which causes more heartache and business failures (or businesses to severely underperform) is success planning.

What sorts of businesses have succession planning issues:

  • Businesses that have been operating for more than 5 years;
  • Businesses where the principals/executives are over 45 years old;
  • Businesses that have high staff turnover in the next generation of future leaders;
  • Businesses where there are no logical successors within the business today;
  • Family businesses where the Sons/Daughters are not interested in being part of it;
  • Businesses where the founders/principals have been part of it for more than 15 years;
  • Small to midsize Legal/Accounting/Medical/Dental practices (from 5 to 20 practitioners) where the major participants do not intend to be there in 5 years; and
  • Businesses where the principals/executives are starting to suddenly encounter the health issues that come with middle age.

In other words, well over 50% of all businesses out there today.

What is Succession Planning?

Succession planning is a process of determining critical roles within the company, identifying and assessing possible successors, and providing them with the appropriate skills and experience for both present and future opportunities.

In other words succession planning covers these important, and often poorly executed, steps:

  • Staffing and Recruitment … You Recruit and Retain superior employees who are right for the business
  • Learning and development … You provide employees with the tools, methods and experiences to develop their knowledge, skills and abilities
  • Leadership … You provide employees with the techniques and practical experience to genuinely – and naturally – be the future leaders of your business
  • Annointment … You make sure that – when the time is right – everybody in the business knows who has been selected to spearhead the succession.  If things change suddenly you do not want your plans to fail do to opportunistic “coups” that take place in the vacuum caused by the sudden changes
  • Performance and Compensation management … You prepare employees for advancement and/or promotion into ever more challenging roles
  • Talent Management … Even though you’ve identified the future leaders, some times you need to replace these superior employees for the long-term future of the business.

Why Do I Need a Succession Plan?

Succession planning is a process by which the successors (future key employees/leaders) are identified for key roles throughout an organisation including vital roles in each department of the business.

Because it (should) take into account the strategic vision and objectives of the business, it means a business with a good succession plan in place, will perform no worse and often much better as a result of the changes caused by the succession.

This is because both employees and customers are ready for the changes when they occur in terms of appropriate skills and experience to have no/minimal impact to business operations (and profitability).

Conversely, businesses without a succession plan in place will inevitably stumble when events occur – such as a sudden death or departure of key executives.  These stumbles manifest as a drop in revenue, earnings and often customers who are dissatisfied with the performance of what was previously a good business relationship.

In fact, many businesses who have not prepared succession plans actually go out of business as a result of the events that triggered the need for that succession plan.

What is in a Succession Plan?

Typical activities covered by a succession plan include:

  • Identify, Define and Articulate the roles and skills which are critical for future company growth
  • Analyse and address each of the gaps (processes & people) revealed by this planning process
  • Identify and Specify the developmental needs of all employees to fill tho key roles
  • Ensure that all key employees understand their career paths and the roles they are being developed to fill
  • Create the learning environment that trains people for skills and positions that may not currently exist in the company
  • Recognise that the employee’s time needed for training/learning as part of the succession plan may mean their current roles need to be backfilled for some time and that this is a cost of securing the future of the business
  • Allow the succession plans to evolve with the business through regular executive discussion of people and roles
  • Identify the top performers in all departments and work openly with them to ensure they are engaged and satisfied to stay with you for a long period
  • Continually manage and monitor the succession processes, and whether planned development for individual employees has taken place AND delivered anticipated/acceptable outcomes

Feel free to contact us, if you want more information, or want to commence a succession plan for your business.