The greatest need in many small businesses is for cash flow. Picture this scenario:
Three people start a business and after a few years it is beginning to make profit – in a year it will go cash positive. One of the shareholders is killed (or disabled) in an accident, leaving the spouse and children desperate as neither the company nor remaining shareholders can afford to buy the dead shareholder’s equity. The family put his or her shares up for sale. The other two shareholders now face the prospect of a new shareholder who may not agree with their strategies. The outlook for the business is suddenly very uncertain.
Had the shareholders put in place a buy/sell policy when they started the company, the death of the one shareholder would not have threatened the business. The policy on the death (or disability) of the shareholder results in the remaining shareholders acquiring the shares and proceeds of the policy going to the family of the dead shareholder.
In this way the shareholders keep control of the business and the family of the shareholder receive a pay out which will help remove the financial uncertainty they face.
Generally, buy/sell policies are governed in terms of a shareholders’ agreement.
If the shareholders have loans then make sure they are covered in the agreement – they will need to be dealt with anyway on the death or disability of the shareholder.
Also ensure the agreement is aligned with your Memorandum of Incorporation (MOI) as the MOI has preference over a shareholder agreement.
Key person insurance
If you have shareholders who are active in your company or you have a key manager(s) and the loss of any of these people could have a detrimental impact on the business, then the company can take out insurance on these key people. Proceeds from key person insurance flow into the company.
Suppose, for example, that you recruit a marketing executive who substantially grows your business. Should this executive be killed or disabled, it will lead to a material loss in sales. Taking out key person insurance will give your company the financial space to recruit and train a new marketing manager and will give you time to make up the lost sales.
Many companies have failed by not providing for the loss of a shareholder or key manager.
Take expert advice when taking out either of these policies as there are legal, potential tax and or death duty exposures.