Protecting Your Client’s Business

John Rowbottam

Private Client Adviser

Shadforth Financial Group

Perth

DISCLAIMER

Shadforth Financial Group Limited ABN 27 127 508 472 AFSL 318613 (Shadforth), is part of the IOOF group.

This document contains general advice and does not take into account your financial circumstances, needs and objectives. Before making any decision, you should assess

your own circumstances, read the relevant Product Disclosure Statement and where applicable, seek advice from a financial adviser and obtain tax advice from a registered

tax agent. Information is current at the date of issue and may change. Information is not complete and neither Shadforth nor any other company in the IOOF group make

any representation or warranty, express or implied, as to the accuracy, reliability, reasonableness or completeness of information (including any projections, forecasts,

estimates, prospects, returns and omissions) or accepts any liability for any loss or damage, however caused, as a result of any person relying on any information provided

in, or omitted from, this document. Past performance is not a reliable indicator of future performance.

• Identifying business risk• Managing business cash flow risk• Managing key person risk• Business succession planning

Identifying Business Risk

Key Business Risks

No matter how small or large a business, or how it is structured, each business willface a number of risks.

Risk protection can be as important as maintaining cash flow.

Business Lifecycle

Risk Mitigation Strategies

Business Debt Cover

Managing Business Case Flow Risk

Business Expense Insurance

Aimed towards small business owners – sole traders & partnerships

Covers fixed business overheads/ expenses in the event of illness or injury for a period of 12 months

Purpose if to maintain liquidity and also cover cost of employing staff to run business

Purpose must be established and reviewed annually

Expenses covered

Rent or mortgage interest repayments

Accounting and auditor fees

Advertising costs

Utility bills ie. Gas, electricity, water, heating

Leasing of equipment or motor vehicles

Professional body subscriptions

Salaries of non-income producing employees

Case Study – Business Expense Strategy

David and Jeff, equal partners in a dental practice

David and Jeff are the only income producing employees of the practice

The eligible business expenses amount to $349,000 or $29,083 per month

As partners they are equally responsible for the practice’s expenses

Calculation

Total expenses $349,000Monthly benefit each $14,542

The proceeds helped to pay for the share of ongoing overheads of the practice without impacting personal cash flow, for a period of up to 12 months.

Managing Key Person Risk

Who is a key person?

A key person is any person whose continued association with the business provides the business with a significant economic gain.

Key person insurance is essentially life, TPD or trauma insurance which provides a lump sum for the business to counteract the financial impact of losing that person.

Key person insurance

Revenue purpose reasons:

• Lost sales revenue or profits

• Recruitment costs

• Temporary replacement

• Training costs

• Remuneration changes

Capital purpose reasons:

• Repaying debt called in by lender

• Protecting ongoing credit rating

• Repaying loans to the key person

• Protecting the goodwill and capital structure of the business

Key person revenue strategy

Key person insurance

Death: $250,000

TPD: $250,000

BluePrint Pty Ltd

$

Garry is a key employee with technical expertise

would take 12 months to replaceWould result in in $200,000 reduction in net

profit per annum

Calculation

Annual fall in profit $200,000Cost to hire replacement $25,000Cost to train replacement $25,000Total insurance required $250,000

The business now has the funding to keep it stable whilst a replacement for the key person is found, recruited and trained

Key person capital strategy

Key person insurance

Death: $321,428

TPD: $321,428

ABC Accounting Pty Ltd

$

Howard is a key accounting employee and part owner with Marion another accountant in the practice

Would require repayment of business loans totalling $225,000

Calculation

Outstanding loans $225,000Total insurance required $225,000Gross-up for CGT $321,428*

*As the proceeds will be received by ABC Accounting Pty Ltd, the proceeds of the TPD insurance policy will be subject to CGT at the company tax rate of 30%.

Substantiation of purpose

Purpose must be established and reviewed annually

Should be recorded through company minutes and book entries

However, substantiation of purpose is not necessarily conclusive

Ownership of insurance

Key person insurance to be owned by business entity

Premiums also paid by the business

For key person revenue purpose, premiums are tax deductible

Tax ruling: section 8-1 of ITAA 1997

Business Succession Planning

Partnership Break-ups

Uninsurable exits

• Management buy out

• Transfer to a family member

• Dismissal

• Bankruptcy

• Retirement

Partnership Break-ups

Insurable exits

• Death

• Permanent Disability

• Sickness or Illness

Business succession agreements

Financial Adviser

Legal Practitioner

Accountant

Circumstances an ownership interest will

be sold

How the consideration

payable will be funded

How will the share interest be disposed

and allocated

How the value of the business

will be determined

Types of agreements

There are two principal types of agreements that form the basis of a complete business succession plan

Valuing a business

• Current market value

• Formula method

• Fixed dollar value

• Independent valuation

Using Insurance as a funding option

The purchase can be funded by life insurance policies taken out on the lives of each owner.

A Buy/Sell agreement coupled with an insurance policy can be useful for a number of reasons:

Remaining owners may not want to work with spouse or partner

Avoid having a third party entering the business

Helps to set out the business valuation therefore avoiding disagreements

Remaining partner(s) retain 100% ownership of the business

Business Debt Cover

Appendix

Appendix

Self ownership

Cross ownership

Company ownership

Trust ownership

Tax implications

Receipt of insurance proceeds

Appendix

Self Ownership

Each person owns their own insurance policyProceeds paid to person/ their estate upon trigger event.Separate buy/sell agreement must be carefully created.May suit businesses with large number of owners.

Advantages Disadvantages

Simple to understand and implement

If succession planning documentation not prepared properly could disadvantage surviving business owner/s

No need to assign policies, therefore likely no CGT issues

Disproportionate costs of premiums

Trauma and/or TPD not subject to CGT

Appendix

Cross Ownership

Each business owners policy owned by other business owner/s

Proceeds paid to surviving business owners

Can be used under buy/sell agreement

Death payments generally do not incur CGT

CGT may apply on TPD and/or Trauma

Appendix

Trust Ownership

Trustee owns the policy on behalf of all business owners

Insurance proceeds distributed appropriately

May suit business with large number of owners

Re-assignment not required, therefore no CGT for life policies