Encounter the Difference

NZ CA is an association of independent Chartered Accounting firms, proactively working together for the benefit of our clients.

Are you managing all aspects of risk in your business?

Published: 3rd December 2018

Author: www.momentumfinancial.co.nz

Published in: TrialBalance December 2018 Issue 65

In 2006 ACC research showed that, of all the businesses that ceased trading, 67% did so because of illness or injury to a key person in the business. What that says is too many businesses are not applying a “risk management plan” across all aspects of their business. 

Putting an effective plan in place requires a relatively small commitment by owners in time but can be instrumental in ensuring the continuity of a business following the temporary or permanent loss of a key person or owner.

A fairly straightforward plan can help, for example, with the following:

•Identify who is a key person in the business

•The amount of revenue or service delivery that person is responsible for

•The impact on the business in the unexpected absence of that person

•How long it will take for the impact to be felt on the business

•Is that person replaceable and, if so, how long and at what cost would it be to have an effective replacement up and running

Of course, any plan needs to be funded. You can use personal savings, borrow money or sell business assets to raise the necessary funding. But those are not the only, let alone the best, options as there is unnecessary impact on the (remaining) owners, their personal estates and on the business. A simple and cost-effective method is to use an insurance contract to fund the risk management plan- ensuring the right amount of money ends up in the right hands, at the right time and from the right source.

Another risk often overlooked relates to the untimely departure of an owner from the business due to death or total disability. How do the remaining owners secure the “departed” owners shareholding? And, just as important, how does the estate or disabled owner secure fair value for that shareholding? Without an appropriate agreement in place, these are some of the potential pitfalls:

•They could end up with a wholly unsuitable business partner in the deceased owner’s spouse or other family member

•The estate or disabled owner could sell that shareholding to any willing buyer, including a competitor

•What value is attached to the business? Certainly, if the valuation is done after the fact then the value has already been impacted- to the detriment of the estate or the disabled owner

•Even where a business is valued, is there a mechanism in place to ensure the valuation is regularly updated

•Even where a shareholder’s agreement or company constitution grants the remaining owners the first right to purchase that shareholding, they are not compelled to do so- let alone offer the fair price for it

•And how will the purchase be funded?

Without a properly funded agreement the simple fact is the business may end up being sold or closed down. By ensuring the bases are covered in an agreement, certainty of outcome can be provided for all parties. The disabled owner or estate is able to receive fair value for the asset, because a proper valuation has been (regularly) done; and a structure has been put in place to ensure transfer of the shareholding against payment of the purchase price. Funding it through the simple and cost-effective method of an insurance contract also means the owners do not need to use personal resources, borrow money or sell business assets to fund the purchase- none of which would lead to great outcomes. Putting a properly funded plan in place could be one of the best investments you make in your business.

Source: www.momentumfinancial.co.nz

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