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Identifying the Risk

In today’s competitive environment survival depends on the ability to respond to change.  The change that could hit your business could be the loss of a key director/key shareholder through death, disability, ill-health or poorly planned retirement.

Many small to medium size businesses rely on the complementary skills and abilities that shareholders bring to a business for day-today survival.  Shareholders often undertake considerable personal financial commitment, bear the increasing responsibilities of compliance and invest much time and expertise in planning for the ongoing success of the business.  With so much at stake a business survival plan is a priority:

Companies Act; Throughout any period of crisis the business will continue to exist as a separate legal entity with enduring financial and legal obligations. One of these ongoing statutory obligations is the prudent management of risk. The Companies Act 1993 Section S135 states that a director of a company must not ‘agree to cause or allow the business of the company to be carried on in a manner likely to create substantial risk of serious loss to the company’s creditors’.

Death or Disability of a Shareholder; It takes as little time as a few weeks after the death or disability of a shareholder for the impact on the financial bottom-line of the business to be felt.  This could mean:

  • Possible restriction on credit terms
  • Severely reduced ability to service debt
  • Foreclosure by creditors/lack of liquidity
  • Personal guarantees are called up placing personal assets at risk (in most cases estate settlements will be delayed as assets are frozen until guarantees are satisfied)
  • Loss of key relationships/goodwill
  • Public perception of instability/staff instability

Liquidation; On the sale or liquidation of a business that has lost a key shareholder, the true value of a business may be lost.  A ‘fire sale’ situation may occur:

  • Stock may be sold at a loss
  • Fixed assets do not realise their book value
  • Debtors start disputing their accounts
  • Substantial legal and accounting costs incurred
  • The investment, goodwill and personal exertion that shareholders have put into the business over the years can be lost.  It may also mean loss of employment for the remaining shareholders.

Transfer of shares; The permanent loss of a shareholder could mean significant reorganisation and potential upheaval to the ownership structure of the company. Without a specifically designed plan to manage the consequences of death or cessation of a shareholders’ employment, ownership of shares are automatically passed on to the deceased’s estate or fully retained by the outgoing shareholder.

How would a transfer of shares affect other shareholders? A deceased shareholder’s share of the business will form part of his or her estate and will usually pass to his or her spouse or children.

  • Will the spouse or children contribute to the business?
  • Will they get along with existing shareholders
  • Will they want to draw dividends rather than reinvest retained earnings?
  • Will they accept reasonable salaries for work performed?
  • The remaining shareholders may desire to purchase the estate’s interest.  There may be issues relating to the willingness of the estate to sell, determining share value and the finance method for the acquisition of the shares.  In the absence of funds to complete the transaction, the estate may seek an outside buyer.  The availability of a suitable buyer willing to pay the desired price may be an additional challenge.

The solution; Whether the shareholder’s incapacity to work is permanent or short to medium term, it is in everyone’s best interest – shareholders, beneficiaries of the estate and family trusts, to formulate a contingency plan to ensure:

  • A predictable outcome in the event of crisis
  • Smooth handover of control and ownership on death or retirement
  • Financial reserves to offset loss and keep the business going through an adjustment phase

The two key tools in an effective strategy to preserve business value are:

  • An appropriately structured buy/sell agreement
  • Comprehensive risk insurance

Funding the solution; Cash is an important solution to most financial problems. No other business tool provides instant liquidity like insurance. Insurance provides liquidity to fund solutions to a business crisis at a time when other finance arrangements may be unavailable or heavily restrictive.

Recent statistics from a New Zealand insurance company;

  • Fact: Average age of Critical Care claimants was 46.
  • Fact: Average age of death claimants was 49.
  • Fact: Average age of Income Protection claimants was 47
    (and duration of claim was 20 months).

Given that most of us expect to retire when we reach the 60-65 age group, this snapshot of a claims profile shows that a crisis could bring our working days or our capacity to work to an abrupt end long before we could ever imagine.  How would sudden death or disability affect your business?

Pre-planning and expert advice can protect your business from the consequences of death or disability of key shareholder.  Bay Financial Partners understands the needs of small businesses and the importance of offering flexible products to minimise risk and enhance the security of small businesses. We recognise an appropriately structured and funded buy/sell agreement as one of the key tools in an effective strategy to preserve business value.

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