What happens when a business owner dies?
When you start up a business, it’s important to have a succession plan in place. This is because if the business owner dies, it can cause a big financial impact on the business, no matter what size of business. Debts, sales, commercial mortgages, employees and customers all still carry on. Without the business owner, this may not always be possible.
Getting life insurance for a business owner can help to provide financial stability until the business share(s) can be sold or the business is liquidated. When a business owner passes away, it is up to either the family or the remaining shareholders to sort out the problem. Without the funds available, it can leave them in a difficult situation.
With a sole proprietorship, the business owner and the business are one in the same. Essentially, if you die, the business dies with you. What would normally happen would the business would fall into the estate. In order to pay off any debts, the business assets would be sold. Anything that is left in the estate is then given to the family via a will.
If business debts are substantial, and business assets cannot cover the amount, then your family may be liable to pay off what’s left. Not only that, but there may be unfinished contracts, suppliers to pay or customers to compensate. This would all come out of your estate too as you’re not a limited company.
What are the costs when a sole trader dies?
If a sole trader were to pass away, the business would either fall to a family member or need to be closed down. Before a business can close its doors, there are lots of loose ends that need tying up. If the business has any debts or a commercial property, these will need to be paid off. In addition to this, finishing off contracts and ensuring customers have received goods and services they’ve paid for.
Suppliers will need to be paid, and some businesses may need to be compensated for any loss of goods. Also, if the sole trader had any employees, a remuneration package would need to be paid to them. All of this would be left to your estate and family to sort out when you are no longer around.
When a partner passes away, it dissolves the partnership. This doesn’t necessarily mean that the business has to end. When individuals enter into a partnership, there are usually written agreements in place so that the business can survive in some cases. Often, the business share would fall into the estate of the deceased individual and the family would need to sell the business back to the remaining partner.
If the partner does not have the funds to do so, the share is at risk of being sold to someone else. Perhaps an unwanted partner or a competitor. The other alternative is that the share cannot be sold, and the family then has a share in the business they may not want.
Buying back the share or closing down the business
It can often be a difficult time if the remaining partner is unable to purchase the share of their business. Contracts need to be changed, debts in their deceased’s partners name will need to be paid off and it can put a strain on both the business and the families of those involved. For small partnership businesses, protecting the business in these circumstances can be even more important.
If you are a small business owner or shareholder
When there are multiple shareholders in a business, the share will still fall into the estate. The stock is then distributed and given to the family. If the spouse or beneficiary of the share is involved in the business, then great. However, if the person who inherited the share has no involvement or interest in the business, it can cause problems.
If the remaining business owners don’t have the cash to buy back the share, the company can be at risk of losing a share to a competitor or unwanted buyer. In particular, if the deceased shareholder is a majority shareholder, some of the other shareholders can lose control of the business.
How can I protect my business and family?
When you run a business, it’s important to think about how many people depend on that business to survive, including your own family. For a small business owner, it is likely that your family’s wealth is tied up in the business. The employees that you hire as well will depend on the business for their income and families.
For shareholders and partners, they also rely on the business and may have put substantial funds into the business to allow it to run successfully.
Therefore, having a protection plan in place can help combat serious financial risks that these people will face. In some cases, it may mean passing the business on to the next generation, but not always if the death of a small business owner comes sooner than anticipated. Small business owners are, particularly at risk.
What happens when my business expands?
When your business becomes successful enough to keep expanding, you should review your insurance coverage. It may be that you invest in a commercial mortgage or you have more employees that are key to the success of the business.
If you have invested in a commercial mortgage or taken out a business loan, you may want to increase your life insurance. However, if your business has increased its assets and profits, you might think you have enough in the bank to cover any debts. It depends on your business circumstances and which directions you choose to take as a business owner.
In addition to this, you may have employed some key members of staff. Taking out key person insurance on them can help bring money back into the business if they were to pass away.
Key man insurance
When you are a director, sole trader or key employee, key man insurance may be the best route for your life insurance. Key Man Insurance can be a tax-efficient policy that insures the key individual and pays the money back into the business. The money claimed can cover a loss of profits, loss of clients, loss of sales, loss of reputation, recruitment, temporary cover, training.
A key man can be anyone that is integral to the success of the business. This can be a director, business owner, sales manager, marketing director or software developer. Their skills, knowledge, input in the business or client base can all contribute to the success of the business.
Key man insurance and tax
Key man insurance can be a tax-efficient policy for some businesses. If the key man insurance is taken out for the benefits of the business, then it can be claimed as a business expense and offset against corporation tax.
If key man insurance is tax-efficient in the premiums, it is usually taxed on the payout.
Sole traders and key man insurance
If you are a sole trader, as you and the business are seen as the same, key man insurance isn’t tax-efficient in this way. However, if the premiums aren’t taxed, it usually means that the payout isn’t taxed, which leaves more money for your family.
Furthermore, if the policy is placed in a trust, the payout is exempt from inheritance tax.
For business owners that are major shareholders, their interest in the business is viewed as personal. Therefore, key man insurance is taxed the same as if they were a sole trader.
Shareholder and partnership protection insurance
In the case of larger businesses, shareholder and partnership protection may be the best port of call. In this case, the individuals take out a policy on themselves or the life of the other shareholders or partners. The partners themselves are the beneficiaries of the money.
In the event of the shareholder death, the money is paid back into the business. The share goes into the estate and then to the family. The family can then decide what to do with the share. They may choose to sell it back to the business.
In order to guarantee the sale of the share from the family to the business, a cross-option agreement is put in place. This agreement states that the family agrees to sell the share at a fair price. In return, the remaining shareholders agree to buy the share at that price.
Protecting both your family and the business
In the case of shareholder and partnership protection, the policy protects both the business and your family. Your family get the price of the share and the business can continue to be run by the remaining shareholders. Therefore, each party is protected, and the process is smooth and non-imposing during a difficult time.
What if I want the share to go to my partner?
Yes, if your company’s article of association does not include a shareholder agreement. You are entitled to leave your business shares to whoever you wish. If your partner has no working knowledge of the business, a shareholder agreement may be a better option. It ensures that they receive the value of the share, without needing to be involved in the business operations.
Ensure you have a plan in place
Losing a business owner can be tough both personally and professionally on all those involved. If possible, it’s best to have a succession plan early on in the process with reviewable terms. This makes life much easier and can guarantee protection for the required parties.
If your main concern is protecting your family, life insurance can be a big help. On top of that, it can also help to keep the business running after you pass away. Life insurance can be tailored to the individual and their specific needs. Ultimately, when a business owner dies, it’s important that something is in place to protect their loved ones and colleagues.