Every successful business in South Africa relies on people, often starting with a founder or business partners. As the business grows, more skills and human resources are required and so the team grows with a salesperson, a managing director, or perhaps a head of operations. The saying often goes: “anyone can be replaced.” As a business that puts people at the heart of what we do, we know that this is easier said than done. Grief and business obligations rarely arrive on separate timelines, and without a plan in place, business owners are often forced to make major financial and legal decisions at the worst possible moment.
While short-term insurance protects physical assets like buildings, goods, and vehicles, business assurance is a set of life-insurance policies designed to protect the business when something happens to the people who make it work.
Business assurance in practice
Business assurance covers a range of different policy-types. This article focuses on the three policy-types that we believe cover the most significant risks to business continuity:
- Buy-and-Sell Agreements: protect the ownership structure when a partner or shareholder dies or becomes permanently disabled.
- Contingent Liability Cover: provide liquidity to protect the business’s credit standing or to protect an owner’s personal estate by covering a personally guaranteed debt or loan account.
- Keyperson Insurance: provide the business with a cash injection to absorb the shock when someone whose skills or relationships are critical to the operations or income, is lost.
Protect your ownership structure with buy-and-sell agreements
What happens to a shareholder’s stake in the business when they pass away?
Ownership in a business is classified as an asset in the estate of the deceased, and as such, can be bequeathed to whoever inherits their estate in terms of their personal will.
This can force the remaining partner(s) into an uncomfortable choice: bring in an unfamiliar new “partner” who might not have the ability, skills or interest in the business, or scramble to find the cash to buy out the deceased’s share, often at short notice and on unfavourable terms.
A buy-and-sell agreement solves this, by creating a legally binding contract between business partners or shareholders that determines what happens to a deceased or incapacitated owner’s stake in the company. In conjunction with the agreement, a buy-and-sell policy structure is implemented to provide funding for the buyout through life insurance policies the co-owners hold on each other’s lives.
When the triggering event happens (typically death, but sometimes also permanent disability), the insurance proceeds pay out to fund the purchase:
- the remaining partners keep control,
- the departing owner’s estate receives fair compensation, and
- the business avoids the disruption of an unplanned ownership change.
The buy-and-sell agreement needs to be carefully aligned with the company’s Memorandum of Incorporation and shareholders’ agreement. This is not a DIY exercise and typically requires input from both a qualified financial planner (to structure and fund the policy correctly) and an attorney (to ensure the legal documents are properly aligned).
Provide liquidity to cover liabilities with contingent liability cover
It is common practice in South Africa for business owners to sign personal surety for a business loan or overdraft facility, since lenders often require it before extending credit, especially to smaller businesses. If the owner dies or becomes permanently disabled, the outstanding debt can become a claim against the deceased’s personal estate. Given how long estate administration can take in South Africa, a family could be left in financial limbo for months, or even years, while the debt sits unresolved.
Contingent liability offers a simple solution, by paying out an amount equal to the guaranteed debt, thereby protecting the owner’s personal estate against business debt claims.
The reverse scenario is just as common and often overlooked. Where a shareholder has personally lent money to their own business through a loan account, that loan is an asset in their estate. The estate is therefore owed the money. Unless the business has the cash available to repay it, the executor cannot finalise the estate.
To account for this, a policy can be taken out by the business on the owner’s life, equal to the loan account balance to settle the debt.
Ensure that the business can continue its day-to-day operations with keyperson insurance
While corporate institutions can easily fund and replace the loss of an employee, the same is not always true for smaller businesses. Many businesses depend heavily on individuals who aren’t shareholders at all, for example, a salesperson who manages most of the client relationships, an operational lead who keeps the whole business running, or a technical specialist whose knowledge can’t easily be replicated. The sudden loss of these individuals can result in loss of clients or severe operational disruption which can hinder profitability and lead to financial constraints ultimately threatening the business’ continued success.
To protect itself, a business can take out keyperson insurance on the life of a stakeholder whose role, skills or knowledge are essential to the continued success of the business. It provides immediate liquidity that allows the business to recover from such an unforeseen loss, and can be used to protect cashflow, replace lost income or cover recruitment and training costs to find a suitable replacement.
Important considerations: Tax, estate duty, and getting the structure right
Business assurance only works as intended if structured correctly. Tax and estate duty considerations are complex and getting the structure right requires specialist knowledge and diligence. Getting it wrong can be a costly mistake and have the complete opposite effect than what it was meant for.
- Premium deductibility trade-off for keyperson policies: Life insurance premiums are not generally tax-deductible in South Africa. However, a special exemption exists for keyperson policies if the policy meets the specified requirements for ownership, beneficiaries, and purpose. If premiums are claimed as a deduction, the eventual payout becomes taxable. This means that the cover amount will need to be increased to ensure that the business receives the right amount of money after tax. Alternatively, premiums can be left non-deductible for tax purposes, which will render the final policy proceeds tax free.
- Estate duty and buy-and-sell proceeds: The structure of buy-and-sell policies is extremely important. For the proceeds to be excluded from the deceased’s estate for estate duty purposes, specific conditions need to be met at the onset of the policy and must be maintained throughout. Should the policy fail one of the conditions, the proceeds can be pulled back into the deceased’s estate and taxed accordingly.
- Trust-held shares: Where an owner’s stake is held through a trust rather than in their own name, the usual estate duty exemption for buy-and-sell proceeds generally does not apply, because SARS treats the trust (not the individual trustee) as the actual owner. This means the amount of cover needs to account for the estate duty that will still be payable.
- Don’t set and forget: Business assurance is not a policy that is taken out and forgotten about. Valuations change, debt levels change, and shareholding structures change. Given the costly implications of incorrect legal and tax structuring, this is genuinely an area where professional advice is a must, not a nice to have.
In conclusion
Building a successful business requires grit, determination, and hard work – all from people who want to make it work. Structured properly and with the right guidance, business assurance creates certainty that if the unexpected happens, the legacy that is left behind is one that can prosper for generations to come.
We express our greatest appreciation towards JWR Financial Services for their insightful contribution to our newsletter through this article.