Why would I get life insurance in a business partnership?

— 8 min read

Whether it is in a medical practice or not, when starting a business partnership, it’s important to ensure you have an exit strategy in place to protect you, your interest in the practice and your family.

The reality is, at some point, business partnerships end. Best case scenario, it may be a voluntary exit at a planned point in time or an unplanned exit whereby one of the partners decides he wants to leave. However, it could be worse, a forced exit due to the death, disablement or illness of one of the partners.

If the exit is forced, it can create a number of issues for the remaining partner or partners of the business. Raising questions that may not have been through at the time the business was set up, such as-

  1.  What happens to the shares in the business that are owned by the departing partner?
  2.  How will the remaining partner or partners compensate the exiting party or their family for their shares in the business?

A buy/sell agreement is normally created at the inception of a partnership and will outline the process for transfer of ownership as well as the funding mechanisms that are to be used.

Generally speaking, the value of the business will be determined at that stage, which will specify each individuals’ stake in that business. It is important to keep this valuation up to-date so the shareholder value is up-to-date at all times in case of a sudden exit.

Some options that could be considered at the time of a forced exit include:

  1.  The remaining partners could take out a loan to compensate the exiting party. This could result in costly interest payments and in some circumstances, banks may not lend funds to a business owner who has just lost their partner.
  2.  Ownership could be transferred to a new partner who buys the shares in the business, thus compensating the partner or their family. However this is only an option if you are able to find an appropriate party to join the business.
  3.  Another option to consider, which can often be the most cost effective and simplest resolution, is buy/sell insurance. In this situation, each partner of the business would have Life and Total & Permanent Disablement (TPD)  insurance in place that reflects their ownership stake. In the event of a death or disablement of a partner, either they or their family would receive a payment equal to the value of their ownership to compensate for their shares.

The shares in the partnership would then be reallocated as per the buy/sell agreement. This means that the family or disabled former partner is adequately compensated for their asset and the remaining partners aren’t left with the burden of finding the funds to pay out the other party.

Buy/sell insurance can help reduce the risks of:

  • Remaining owners whilst having to sell the business to fund the payout of a departing partner
  • The family of the exiting owner deciding to continue owning the shares in the business against the wishes of the remaining partners
  • The exiting owners stake being sold to an unsuitable third party
  • Expensive interest costs if a loan is needed to pay out the exiting partner

Having a current buy/sell agreement with the right funding methods in place can help reduce the mental and financial stress of a forced exit, making what can be a very difficult time slightly easier for all parties involved.

An Insurance Consultant can evaluate the market, find the best fit for your situation and ensure your cover compliments the other insurances in your protection portfolio. If you would like to learn more about buy/sell insurances or discuss your personal situation, call 1800 376 376 or book a no-obligation initial consultation with one of our insurance specialists.

Also read Should you consider business expense insurance?

Disclaimer: * The information contained in this site is general and is not intended to serve as advice. DPM Financial Services Group recommends you obtain advice concerning specific matters before making a decision.

Authors

Tom Rogers

B. Comm (FinPlan)

Consultant
Melbourne

Connect on LinkedIn

Tom joined DPM in 2016 and has more than 8 years industry experience. He establishes close relationships with his clients and provides holistic insurance advice to ensure both themselves and their families have financial peace of mind.