Ensure peace of mind for all the owners in your business that their personal estates are protected, the continued existence of the business is protected and also for the clients of the business that the business will be able to continue with its normal day-to-day functioning if something unforeseen should happen that could otherwise ruin the business. Read more about the different needs that could be identified in the business by clicking on the appropriate link.
Potential Business Insurance Needs
Suretyship Protection
The need:
Business owners often conduct their businesses through limited liability entities, because they wish to protect their personal estates from creditors if the business venture fails. Suretyship agreements effectively remove the benefit that these limited liability entities offer, as they remove the vital separation that there should be between personal financial affairs and business obligations. As a result personal assets are exposed to business risks and this situation invariably affects personal estate planning negatively.
Problems relating to suretyship:
- Without suretyship protection insurance, the following problems may arise:
- The executor may be forced to sell estate assets to provide liquidity.
- Business debts may have to be settled to the disadvantage of heirs and dependants.
- The estate administration process may be delayed.
- The estate may be declared insolvent if total business debts exceed personal assets.
- Dependants may have to sell assets or borrow funds at great expense to maintain their standard of living.
- The continued existence of the business may be placed in jeopardy.
The benefits of suretyship protection:
Should sureties die or become disabled, suretyship protection insurance provides them with peace of mind that the business debts will be settled immediately and without their personal estates being held liable. The plan makes sound financial sense because the monthly cost is very small in relation to the benefit.
- The suretyship protection plan offers the following specific benefits:
- The outstanding loan/s covered by the suretyship agreement are settled on the death or permanent disability of the surety.
- The untimely death or permanent disability of the surety does not affect the business’ liquidity and continuity is ensured.
- No substitute surety is required as the debt is settled in full and new facilities can be negotiated afresh.
- The surety’s deceased estate can be wound up without unnecessary delays.
- The surety’s personal estate is not affected in any way by standing in for business debts.
The structure:
Should the surety die or become disabled, the creditor may wish to call up the loan even though the principal debtor is still making repayments. Suretyship protection is a life insurance policy taken out by a principal debtor on the life of an individual who stands surety for the debts of the principal debtor. If structured correctly, the insurance policy will provide sufficient funds to repay the outstanding balance of the debt, thereby releasing the surety’s estate from this liability.
Loan Account Protection
When any business starts out, it requires financing to be able to purchase any essential equipment, stationery or other items, as well as to be able to pay the regular expenses like salaries, telephone expenses, rental, etc. When a business has no assets, there are only two ways to raise this financing, either by issuing shares or borrowing money. Because the owners do not want other people involved in the business, they normally rely on the loan method. The simplest route would be to go to a bank or other lending institution, but it is important to remember that they all ask for security and charge interest on any loan. If the business is not able to provide sufficient cash flow to meet this obligation, the alternative is for the owners and/or directors to make a personal loan to the business. The terms of such personal loans are normally done informally with no written contract, with no fixed term and do not reflect the payment of any interest. This is reflected on the balance sheet of the business as a long-term liability that only needs to be repaid at an indeterminable future date.
The need:
The need of the business is therefore to be able to repay the loan on demand if called upon to do so by the owner/director, or any other person like an executor who may be authorised to act. This might occur when the owner/director becomes disabled or passes away. If the business is not in a position to settle the loan at that time, it might be declared insolvent thus negatively affecting all concerned. Proper financial planning would aoid such consequences.
The solution:
The solution is for the business to insure the life of the owner/lender for an amount equal to the outstanding loan. This is a simple, inexpensive and efficient way of ensuring that cash is available at the required time.
Business Overheads Cover
To cover the running expenses of a business when a key owner is absent due to disability and he/she is unable to contribute to the normal turnover.
Implementation:
The Business identifies the key owners, on whom it depends for the generation of the business’s income. The business insures these owners’ lives so that if they become disabled, either permanently or temporarily, the insurer will pay a monthly amount to the business. The business uses such amount as it deems fit in the settlement of regular fixed expenses.
Features of the solution:
Certain business expenses are included, whilst excluding others.
Business expenses included: 
- Rent or mortgage bond interest.
- Property taxes, electricity, water, telephone costs.
- Regular maintenance services cost.
- Equipment leasing costs.
- Insurance premiums.
- Accounting fees.
- Salaries of staff not engaged in the same profession.
Business expenses excluded:
- Depreciation.
- The salary or other earnings of the policyholder, members of his family, any person performing the duties of the policyholder in his/her absence, or business associates.
- The cost of goods or merchandise or additions to inventory.
- The cost of furniture and equipment.
- Fees on current account.
- Capital repayments on any outstanding debt.
Keyperson Cover
The need:
Being in business means that business owners must accept a certain amount of risk. Key person insurance is an effective method of transferring the financial risk related to the loss of key employees to an insurance company. Key person insurance also provides contingency capital to fund the costs of recruitment, retraining and replacement of a key person.
Without key person insurance, the following serious implications could arise for the business on the loss of such a key employee:
- Profits may be affected temporarily or permanently.
- Clientele may be lost.
- The creditworthiness of the business may be negatively affected.
- Huge recruitment and training costs will be incurred.
The solution:
Where key employees contribute substantially to the success of the business, the business can take out insurance on the lives of those people. Should a key person then die or become permanently disabled, the business would receive the policy proceeds and could use it to offset the loss of profit or expenses associated with the loss of that person’s contribution to the business. The value of the life cover should represent the value of the key employee to the business in monetary terms.
If the key employee dies or becomes permanently disabled, the business receives the policy proceeds that it then utilises to reduce the financial strain on its cash flow and profits.
The benefits:
With keyperson insurance, business owners have peace of mind knowing that the business will survive the loss of a key person, as they have provided immediate capital for the business. The plan also makes financial sense because the monthly cost is very small in relation to the benefit.
Key person insurance offers the following specific benefits:
- The policy proceeds will cover the costs of recruiting and training a new employee.
- The business replaces any loss of income and profits.
- The creditworthiness of the business remains intact.
- Directors’ loan accounts can be repaid.
Debtors Cover
Can one avoid this situation? Yes, with foresight and proper planning!
The need:
The management of default-risk requires timely identification of potential problem areas and the implementation of an appropriate action plan. The type of client for which one could effectively utilise this, would be a debtor business with a single owner or where the amount outstanding will have a significant impact on the creditor’s cash-flow should it not be repaid.
The solution:
The appropriate use of a life insurance policy can reduce this risk substantially by insuring the debtor’s life against death or permanent disability. The creditor can accomplish this in one of two ways:
Option 1
The creditor identifies a debtor for whom this scheme is required, and then applies for a suitable life policy on the debtor’s life. The creditor will be the applicant/owner, premium payer and beneficiary for the proceeds. The creditor then adds the policy premium to the sales price/invoice for the goods or services sold, which the debtor has to repay.
Option 2
The creditor insists, as a condition of credit, that the debtor takes out and pays for a policy on his/her own life. The debtor then cedes the policy collaterally to the creditor for as long as the debt remains unsettled. Once repaid, the cession can be cancelled. If the debtor passes away or is declared permanently disabled from performing his/her work functions while the debt is outstanding, then the policy will pay out to the creditor. The creditor offsets the amount received against the debt and repays any excess to the debtor’s business or estate.
The benefits:
- The proceeds from the insurance policy settles the outstanding debt in full on the death or permanent disability of the debtor.
- The creditor receives payment immediately after a successful claim is lodged.
- Should the policy proceeds be payable to the creditor, the death of the debtor will not negatively impact on the business’ cashflow.
- The creditor can keep control of the risk while being able to choose which structure suits it best.
- The cost of a life policy is inexpensive relative to the debt amount and the financial impact of non-payment.
- The debtor’s estate and business is released from liability for the debt due to its settlement in full.
Alternative Financing
Businesses usually structure the purchase of assets – whether these are immovable property, machinery or equipment – and operating capital through traditional banking products. The terms of the traditional loan facility/structured finance deal are such that the business pays back both capital and interest over the specified term. The result of this method is that by the time that the business has repaid all the capital, it will need to start from the beginning again to refinance a replacement asset.
Is there an alternative repayment method? The answer is YES.
The need:
The need is to structure a bank loan in an alternative manner that will offer business clients who are entrepreneurial by nature and are willing to take calculated risks, an opportunity to achieve other benefits for themselves.
The solution:
The bank consents to the business structuring its repayments so that it pays interest only over the specific term of the loan/structured finance deal. The business couples this with an investment to build up capital that will have a minimum return equal to the outstanding capital balance at the end of the term. Through the Momentum Alternative Finance Repayment scheme a business can create an alternative asset for itself that could generate additional wealth and other benefits while guaranteeing it a minimum payout from a variety of funds.
The benefits:
Some of the benefits of the Alternative Repayment Scheme include:
- Increased tax deductions
- Tax-effective capital extraction
- Gearing
- Enhancing security
- Increasing and replacing traditional suretyships
- Diversifying to an alternative investment type
- Increasing the value of the business through the creation of an on-balance sheet asset
Corporate Investment
As a business owner you are aware of certain large expenses you will need to pay in the future or any capital items that you will need to acquire or replace. The cost of these items must either be paid out of the business’s cash-flow or through bank financing. If the bank loan route is followed there are two additional expenses, ie interest and a deposit that must be taken into account. How do you overcome this problem? Through holistic financial planning!
The need:
To finance the future business expenses in a structured and cost effective manner by making use of any tax concessions that may be applicable.
The solution:
By structuring a regular investment in the business’s name, you are able to make timeous provision for the future expense without placing undue pressure on the business’s cash-flow or profits. The Corporate Investment does just that. Usually you will have a choice of investment products in which to house the financial provision that can be considered together with a qualified financial planner. The actual circumstances of the business will determine the suitability of each investment type by considering various factors like the term, accessibility, protection and tax. In addition, you may choose to invest sufficient amounts to cover all the items in one contract or you may prefer a combination of investments.
How can you calculate the required recurring contribution?
- Firstly, the current and future cost (taking an assumed inflation rate into account) that is required for each expense or capital item is established.
- Secondly, the term is calculated by determining when you need the money.
- Thirdly, account is taken of any existing provision (with ongoing growth) in order to ensure the solution is appropriate for the need.
- Fourthly, an anticipated investment growth rate and any escalation in the regular contributions are factored in.
Once all these factors are established a financial calculation is done to determine the required regular contribution. The capital value thus created can be used to either pay the expense, buy the asset or pay for a portion thereof.
How can you afford to pay this contribution?
Can you afford to make the required contributions? The actual question, bearing in mind that SARS helps in this regard through tax deductions, is can you afford not to? By making use of the available deductions to make adequate provision you will be converting a book entry into an actual asset.
SARS allows a tax deduction for the actual amount of money spent on expenses that are incurred in the production of taxable income. This basic deduction in terms of section 11(a) of the Income Tax Act (ITA) includes the interest on loans used to finance production and the cost of any lease on assets employed. In addition, section 11(e) of the ITA allows a deduction for the depreciation of an asset over its useful life when it is used in the production of income.
Should you be classified as a “small business” and your annual turnover is less than R20 million, you may also qualify for a reduced corporate tax rate. This concessionary rate amounts to 0% on the first R73 651 of taxable income, 7% on the next R297 888, 21% on the next R185 000 and only thereafter will you pay the normal corporate rate of 28%.
By claiming these deductions in your business you will be reducing your income tax liability e.g. if your normal taxable income is R1000, your income tax payable would be R280. If you have a tax deduction of R280, your taxable income will reduce to R720 and the income tax payable thereon will reduce to R201.60. You have therefor saved an amount of R78.40 that can be used to finance the Corporate Investment. SARS will in fact be helping you provide for the future.
The benefits:
- Some of the benefits for the business are:
- Good corporate governance by making adequate provisions.
- Growth of alternative assets within the business, thus increasing its value to the owners.
- Replacement of long-term liabilities on the balance sheet with fixed assets, thus improving the gearing ratios.
- Improvement of the creditworthiness of the business.
- Systematic and structured investment for a future expense.
- Use of the SARS allowances to subsidise the cost.
- Creation of an investment that can generate tax-free capital after five years.
- ‘Parking bay’ for retained income in the future due to the ‘black hole’ loan facility created.
Business Continuity (Buy-and-Sell Insurance)
Most people spend a great deal of time and effort planning, establishing and operating their biggest asset, a business. Many entrepreneurs also consider it to be the source of their retirement capital, as well as income for their families when they are no longer able to run the business.
The need:
Unfortunately, experience has shown that only a limited number of business owners take the time to consider the practical consequences of an unexpected death or disability. How long would it take to find a willing buyer for your business? Would their family receive a market-related price for their business interests? What would be the impact on staff and creditors and how would this affect the continued existence of the business? The solution is a business continuity plan, also known as a buy-and-sell agreement.
The solution:
The business owner finds someone who understands his business and would be interested in taking over ownership. He then concludes an agreement with the buyer(s) in terms of which the owner’s interest in the business will be sold to the buyer(s) in the event of the owner’s death or permanent disability. It is thus possible for sole proprietors or sole-owners to also enter into such an agreement to sell their business. Examples of potential buyers are current co-owners, staff members, competitors or, in the case of a company or close corporation, the corporate entity itself.
The business owner could enter into such a contract by verbal agreement, but because the existence of an agreement might be difficult to prove later, it is recommended that the contract should be in writing wherever possible. This is a contract of sale and purchase and, as such, must contain certain essential terms and conditions. These are:
- the full details of the seller,
- the full details of the buyer,
- a description of the item(s) to be sold and bought,
- the price of the business interest and how it will be financed, and
- the circumstances under which the contract can be executed.
It is essential that the seller and buyer agree on the value of the business interest otherwise no contract can come into being. The starting point should be to determine how much a willing buyer would be prepared to pay, and how much a willing seller would be prepared to accept for the business. It is recommended that the parties decide upfront on the valuation ethodology to be used, in order to avoid disputes in the future. The agreed valuation method can then be incorporated into the contract.
A experienced financial planner will help you determine the value of your business.
This valuation method is then used to determine the purchase price at the inception of the contract. The next step is to determine how the purchase price will be funded. The buyer may attempt to build up sufficient capital by way of investments, but this is a risky option because one does not know when death or disability might occur. Life assurance offers a cost-effective and practical solution to this problem. The buyer should take out insurance on the life of the seller in order to receive sufficient capital to cover the full purchase price. While a new insurance policy is preferable in order to avoid adverse estate duty and capital gains tax consequences, the client may always choose to use an existing policy if his/her application for a new policy is likely to be declined due to poor health or old age.
The benefits:
This agreement provides business owners with a plan that would enable the business to continue operating if one of the owners/co- owners were to die or become permanently disabled. Without it the following problems may arise:
- potential buyers of the business interest may not be readily found,
- family members of the seller may become entitled to a share in the business by way of inheritance and may have no interest in, or knowledge of the business,
- the business interest may be sold for an amount that is below fair market value, thus jeopardising the effectiveness of the seller’s estate planning,
- it may adversely affect the relationship with creditors and banks and they could call in their facilities,
- large capital sums will be needed to fund the purchase of a deceased or disabled co-owner’s interest at a time when the buyer(s) is/are unable to raise sufficient funds, and
- quality staff members would not be attracted to the business and existing employees would be uncertain of their future and might resign.
Income Replacement
The need is for the business to insure itself against the risk and costs associated with the situation where the owner or an employee/employees are unable to perform their normal functions at work due to temporary or permanent disability.
The insurer will pay a monthly claim amount while the insured life is temporarily or permanently disabled as a result of a bodily injury or illness to such an extent that he/she is continuously unable to perform the duties of his/her own occupation.
Loan Account Redemption
When any business starts out, it requires funds, possibly through financing to be able to purchase any essential equipment, stationery or other items, as well as be able to pay the regular expenses like salaries, telecoms, rental, etc. When a business has no assets, there are only two ways to raise this financing, either by issuing shares or borrowing money. Because the owners do not want other people involved in the business, they normally rely on the loan method. The simplest route would be to go to a bank or other lending institution, but it is important to remember that these all ask for security and charge interest on any loan. If the business is not able to provide sufficient cash flow to meet this obligation, the alternative for the owners and/or directors is to make a personal loan to the business. The terms of such personal loans are normally agreed informally with no written contract, with no fixed term and do not reflect the payment of any interest. The balance sheet of the business reflects the loan and interest as a long-term liability that only needs to be repaid at an indeterminable future date.
The need:
The need of the business is therefore to be able to repay the loan on demand if called upon to do so by the owner/lender when the owner/lender wants to retire. If the business is not in a position to settle the loan at that time, it might be declared insolvent, thus negatively affecting all concerned. Proper financial planning can avoid such consequences.
The solution:
The solution is to structure the repayment of the loan over the term between the current time and the anticipated retirement date of the owner/lender . This will ensure that the minimum financial stress is put on the cash-flow of the business and that the business can repay the loan in the most tax-efficient manner by the required date.
Staff Retention
Employees are no longer content to work for one employer for the rest of their active lives without sufficient compensation. In addition, employers have come to realise that the turnover of staff have serious financial consequences for their businesses. It has become imperative that employers find additional methods to retain the services of such staff members.
The need:
Employers who have highly valuable or key employees may find it very difficult to retain their services in the face of competitors offering better remuneration packages. In addition, the loss of employees with special skills or knowledge may result in a financial loss to the employer. While salary increases may provide a solution, they do not guarantee that the service of key employees will be retained.
The solution:
The basic solution is some form of financial incentive, over-and-above the employee’s salary, which should discourage the employee from leaving. This can be done through a cash payment (bonus) paid from an investment scheme, participation in profit share or via a share option scheme.
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