What Is Buy/Sell Insurance and Why Does Your Business Need It?

What Is Buy/Sell Insurance?

Running a business with other owners means planning for the unexpected. Buy/sell insurance can provide funding if an owner passes away, becomes seriously ill or can no longer work, depending on the policy.

This funding can help the remaining owners purchase the departing owner’s share and help ensure that their family or estate receives the agreed value of their interest in the business. Put simply, it can act as a financial safety net during a difficult transition.

It’s important to remember that insurance doesn’t determine who takes over the business. That’s the role of a Buy/Sell Agreement, which outlines what happens to an owner’s share. The insurance can then provide funding to help put those arrangements into action.

The right approach depends on the business, its owners and the level of cover required, so the strategy should be tailored to your circumstances.

How Does Buy/Sell Insurance Work?

Buy/sell insurance works alongside a Buy/Sell Agreement to help make a transition easier to manage. While the agreement sets out what should happen, insurance can make it easier to access the funding needed to put it into effect.

Step 1: Establish the Agreement

The business owners need to agree on what will happen if an owner dies, becomes disabled or experiences another agreed event. The Buy/Sell Agreement outlines how their share will be transferred.

Step 2: Determine the Funding Needed

The owners consider what each share of the business is worth and how much funding is needed in the event of the transfer.

Step 3: Put the Right Insurance in Place

Appropriate insurance can be arranged to provide funding if a defined insured event happens. The policy should work alongside the Buy/Sell Agreement.

Step 4: Put the Plan into Action

If the insured event happens, the policy proceeds can help fund the purchase of the relevant share. This provides greater financial certainty for the remaining owners and the impacted owner’s family.

The important part is making sure the insurance and Buy/Sell Agreement work together. 

Why Businesses Use Buy/Sell Insurance

Running a business with other owners means thinking about more than day-to-day operations. It’s also worth considering what happens if one owner can no longer continue. Buy/sell insurance can assist in providing clarity in these situations.

Supporting business continuity is one of the key reasons businesses put Buy/Sell Insurance in place. Having an agreed plan for ownership can reduce uncertainty and help the business continue during an already difficult time.

Providing funding is equally important. An owner’s share of a business can represent significant value, and the remaining owners may not have the funds available to purchase it themselves. When structured appropriately, insurance can provide the funding needed to facilitate the transfer.

Reducing uncertainty can also make a significant difference for everyone involved. When the process has been agreed in advance, owners and their families have a clearer understanding of what will happen if the unexpected occurs.

This can also help protect relationships by reducing the potential for confusion or disagreement around ownership at an already challenging time.

Who Should Consider Buy/Sell Insurance?

Buy/Sell Insurance isn’t only relevant to large businesses. It may be worth considering for any business with multiple owners where an unexpected change in ownership could have a significant financial or operational impact.

This can include partnerships, private companies with a small number of shareholders and owner-operated businesses, particularly where individual owners play important roles within the business.

In saying this, buy/sell insurance may not be right in every business. The need for cover depends on factors such as structure, ownership arrangements and financial position. It is usually most impactful when it makes up part of a broader succession strategy instead of a single solution.

Common Mistakes Businesses Make

Even with a clear succession plan in place, challenges can still arise as the business adapts. Avoiding these common mistakes can make all the difference in keeping your plan in-tact.

• Not updating the agreement as the business, ownership or roles change.
• Relying on outdated business valuations, which can leave the level of insurance out of step with the value of the business.
  
• Leaving succession planning too late, rather than preparing before the unexpected happens.
• Not aligning the insurance with the Buy/Sell Agreement, so the funding may not support what the agreement sets out.
• Not reviewing the strategy regularly to make sure it continues to reflect the business and its owners.

Protecting Your Business with Buy/Sell Insurance

It’s impossible to predict the changes your business may encounter, but you can plan for how you’ll respond. A strong Buy/Sell Agreement can clarify ownership, while a tailored insurance policy can provide the funding needed to support the transition. This is bolstered through constant review and accurate documentation.

At Panorama Financial Services, we help businesses to develop tailored buy/sell strategies that align with their company and goals. Whether you’re reviewing an existing arrangement or putting a new plan in place, you can depend on our advisers to steer you in the right direction.