Sunday 5th June, 2005

 

Insurance proceeds for business continuity

 
 
 
 
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Money Matters
with Raziah Ahmed

Parkinson’s Law is a theoretical construct, which says: “Work expands to fill the time available for its completion.” The trick then must be to know all and every facet of the work to be done, so that we have the requisite time to do it all.

One reason that small business owners, and one-man professional businesses tend to have no real structured pension plans and health plans, or succession planning, is because these aspects of the job were never conceived as part of the business in the first place. Usually these aspects of the business are after thoughts, and time is hesitatingly allocated to attend to these important matters.

The illusion tends to be that “I can make money faster than you can invest in pension plans, or else that health insurance is an employee benefit for which business owners have to fork out cash.

Last week we looked at key person insurance, and critical illness insurances as means to ensure that cash will be available for business continuity, in the event of disability or death.

The buy-sell agreement is a legal document, normally drawn up by a lawyer, that describes how the money realised from the policy proceeds will be used. Such agreements are crucial for business continuity and safeguard against misuse or misappropriation of the insurances proceeds.

Limited liability companies have shareholders who own specific amounts of shares, which represent equity, or ownership of the business.

Upon death of a key person who is a shareholder, the legal heirs to those shares become business owners. Is there a danger in this? Yes there is, unless the heirs are themselves astute business people, or have been actively involved in the business.

The danger can be that incompetent or inexperienced persons becoming decision makers by virtue of their capacity to vote at board meetings. The danger can also be a need to grab for lost income (the result of the death of a bread winner), so the heirs may now insist upon their own employment in the business.

The buy-sell agreement would avoid such predicaments, by mandating, for example, that heirs sell off their shares to the remaining owners/key persons. The money to buy the shares from the persons who have inherited shares could come from the insurance proceeds.

An alternative to insurance protection in this scenario could be the establishment of a sinking fund. A sinking fund is merely the establishment of a stream of savings in deposits, which can be accessed if untoward events unfold.

Prudent investment will add value to the fund, but the business will pay dollar for dollar to finance the buy-sell mandates, unlike that using an insurance solution.

There is an old school in organisation behaviour theory, put forward by Lyndall Urwick in the UK in the early 50’s, called the ten Principles of Organisation. It talks about objective being a principle, which is an expression of the business purpose. It also singles out these elements as principles: authority, definition, span of control and correspondence.

More particularly, it supports the view that the principle of continuity should be in the genesis of every business plan and incorporated into the planned structure. The essential element is that re-organisation is a continuous process, and specific provision must be made for contingencies with the potential to disrupt the business.

It should not be an afterthought to structure for death, retirement and ill health, but ironically, the Peter Principle is also a truism: in an hierarchy, everyone will tend to rise to his highest level of incompetence.

 

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