Will exiting your business achieve its sole purpose?
One of the major risks we come across with business owners is a lack of diversification of their wealth. Too often we see business owners putting all of their reliance on their business being the wealth they want at retirement. A business, like any investment, needs to be part of a well diversified portfolio and where there is too much reliance on this one asset there is a greater risk that needs to be managed.
At a recent Hunter Business Chamber Development Forum, Pitcher Partners principal Simon Johnson highlighted a major risk facing many business owners – the prospect that there may not be a buyer for your business when you want to sell. With more busi-nesses for sale and not enough buyers this will result in a lower price than many business owners are anticipating.
This is the risk that awaits business owners if they are lucky enough to make it to the point of being able to sell their business but almost 50% of business owners (and workers in general) will be forced to stop working before their expected retirement date due to injury or illness. So what happens if you have to exit your business early? How will you realise the value you have created in your business? Who will want to purchase your business? What will your lenders do if you are not working in the business as much? What about your customers?
From the day you start business you should be considering what plans you have in place to exit the business, whether this is voluntarily or forced upon you. It is important to prepare and review a risk management strategy focussed on how you will extract the value from your business. As with any risk management plan you need to identify the risk to understand what impact there is and then finally how much of that impact you are prepared to accept. When it comes to managing the risks associated with forced exits due to injury, illness or even death, insurances are a valuable means of transferring the financial impact of these risks.
There are a number of types of insurances available but one that has come under closer scrutiny from the tax office recently is the funding of insurance associated with buy/sell arrangements.
There are a number of ways the insurance component of your buy/sell arrangement can be funded and superannuation (commonly through self-managed superannuation funds) has been seen as an effective means. However the ATO recently presented the view that where the insurance held within superannuation is in-trinsically linked with a buy/sell arrangement there is a problem. For a SMSF that problem could include contravening the sole pur-pose test and be also seen to be providing financial benefits to a member.
During the life of a business there is a risk injury or illness will impact the operations and value of the business. At the end of the business there is a risk the owners will not be able to realise the value they have built. Understanding and planning for these risks is something that all business owners should do from day one.
Insurance is one strategy for managing these risks but be careful how this is structured to ensure you are not increasing the risks in other areas of your family group.