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Navigating the icebergs: Keeping the successful SME afloat

You took the plunge and set up your own business. After all the research, planning, investment, late nights and sheer hard work, it now has increasing cash-flow, great staff and happy clients.

Now you’ve created a successful small or medium-sized business, you should feel proud – and it’s often the time business owners feel confident enough to expand or invest more while the good times roll. 

Banks and investors might now be more willing to finance Kiwi SMEs, but even a small business loan could soon become a liability if an owner or key person gets injured or sick. This is magnified by those who leverage their biggest asset, the family home, to pay for further expansion.    

There are ways you can keep enjoying what you’ve achieved and ensure that, if something does go wrong, you’re covered.

Here are five tips for ensuring your business lasts:

1. Insure your biggest earners – key person insurance and start-up protection

Whether it’s a shareholder, business owner or chief sales person, losing the people that contribute to the business the most financially (or equally through the loss of intellectual property), can be a huge financial blow for small business owners.

Key person insurance injects a lump sum of cash into the business in the event of the key person’s death or inability to work. The money can help pay for a replacement staff member or for losses in revenue. Sometimes, it’s a case of needing both given replacing staff can take at least a month in most cases. Every business should be thinking about who it can’t afford to lose and protecting itself against the impact of that happening. An injection of cash is also invaluable for demonstrating to staff and clients that the business remains stable and has a secure future.

A similar option for new businesses is start-up protection. New ventures rely heavily on their founders, not just for their vision, and often can’t function without the direction of that key person at least in the early times. Start-up protection is designed to support businesses that have been trading for less than three years and will give the business invaluable cash flow to be used as a personal income or to fund a temporary replacement.

2. The show must go on – continuing business obligations

In the event of a key person suffering an illness, business expenses protection can ensure all the ongoing incremental debt – lease obligations, vehicle expenses, water and power bills, and internet charges – are all covered until the business can continue trading. This means all the overhead expenses are taken care of while the business owners or shareholders can make important decisions about top-level strategy.

3. Set business arrangements in stone – shareholder cover and buy-sell agreements

If you’re like most Kiwi businesses that set out after an enthusiastic coffee or beer with a friend or an owner-operator launch after a couple of years in the industry, determining a company structure is especially important.

The structure of a company very much influences the type of insurance structure, but what stays the same is the legal agreement companies need from their lawyers. This buy-sell agreement determines what happens to the business if one shareholder dies or is disabled. Uncertainty prompts a lot of knee-jerk reactions by staff, investors and estates, so having processes in place save all of that.

A buy-sell agreement should be based around the valuation of the company and reviewed every year. The co-shareholder insurance provides the funds to buy out the deceased or disabled shareholder to the agreed value and be instructed to go to the person’s estate in exchange for their shares.

Equally, debt protection (be that through a loan, overdraft, equipment or stock) can pay off anything the business owner/company owes the bank to save the debt being passed to other shareholders or the estate.

4. Business succession planning – what happens to your business when you’re gone?

Succession planning is a vital part of preparing your business to last.

Many businesses arrange for particular employees to take over the business in the instance of disablement or illness or accident to the key person, or for the estate to sell.

The succession plan can be added in the buy-sell agreement and facilitated by insurance cover.

5. ACC isn’t enough – know your options

First and foremost, business owners, especially owner-operators in the trades, need to remember that ACC covers only for accidents (not illness) and only pays up to 80 per cent of a person’s income.

My experience is that many small businesses are put into a PAYE structure by their accountants for which they pay levies to ACC to cover themselves for those accidents. Another option for owners of a company is to become a non-PAYE shareholder, which allows them to set an agreed amount through ACC (usually the minimum allowed) which in turn reduces the ACC levy.

By then “topping up” that reduced levy with an investment in income protection, they become covered for illness and injury at a specified amount.

Sole traders have the ability to elect how much they want to receive as soon as they start in business. It’s worth noting that ACC only covers proven taxable income, which means many new sole traders won’t be covered until after their first full tax year which could be up to 18 months after starting their business.

The case study

The best way to demonstrate the benefits of insurance are to consider ways in which it has worked for others.

A few years ago we helped a multi-million dollar company claim money from its insurance cover that secured the future of the company, its shareholders and its employees.

One of the original three shareholders suffered from an aneurism and passed away, leaving a significant gap in the company’s skill set and revenue generation.

Key person protection ensured that there was an instant cash injection to float the company’s cash-flow that would have otherwise been earned by the deceased shareholder and also aided the recruitment of a person who could handle the workload.

The company’s buy-sell agreement then kicked in, instructing the shareholders to pay the deceased shareholder’s estate the value of the shares. This was all done without any impact on the company’s performance or financial position.

A summary

Five things that can sink a SME:

  • Failing to plan cash-flow – preparing for the highs and lows.
  • Not taking out insurance protection for key people.
  • Thinking ACC takes care of them and planning for accidents and not illness.
  • Not agreeing on what happens if a shareholder dies or becomes ill – every partnership or company needs a lawyer to draw up a buy-sell agreement.
  • Not opting for debt protection insurance – companies that sell physical product can rack up significant debt.
Brenden Van Schooten is an Authorised Financial Adviser for Lifetime. His 14 years in financial advisory were preceded by experience as a small-business owner and a position as operations manager for a medium-sized Kiwi enterprise. 
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