Here’s a bit of advice. Don’t get stuck with a widower. That’s not something gleaned from the pages of a dating website for older women. It’s proper business advice and it applies to men too. Avoid widows.
My business partner and I had ‘the death chat’ years ago when our company started getting serious. The firm had a prosperous future, but what sort of mess would we be in if one of us dropped dead?
In our case we’d have a double mess on our hands. We ran an investment firm and our skills were largely gained offshore. It wasn’t possible to just pluck a replacement from the New Zealand financial industry. We’d already discovered one Kiwi working in London and promptly employed him. These gems were hard to find.
The second mess would be the value of the shares. Both husbands were clever chaps and knew they’d be holding something successful. Neither would have rolled over easily and allowed their shares to get purchased for a song. Where would the money come from to buy them out?
Insure the problem
There are 500,000 small businesses in New Zealand. Vast numbers of Kiwis are shareholder-employees just as we were. A business partner dies and suddenly their estate owns part of the company. Do you want to get stuck with their husband or wife as a shareholder? And do they want to get stuck with you?
If not, you need Shareholder Protection Insurance. It’s just a big word for Life Insurance. The payout can be used to buy back the shares of the deceased business owner.
Also consider Key Person Insurance. That’s another flash word to describe a policy that pays out an income to employ someone else.
The lawyer and the chef
In our death-chat, we discussed how I’d end up with a widowed lawyer – possibly useful at first glance. But this was a partner in a busy law firm with children to look after. He could hardly come on board as an employee and replace his wife. On the flipside, she would end up with a widowed chef. Only useful if she wants to be fed chocolate gateau on her tenth review of a Prospectus.
Humour and honesty are the best medicine in imagining your own demise. We were left shaking our heads. Widowed husbands were no good to us. They’d be holding the shares, doing none of the work and we needed a method to pay them off and send them on their way.
Cash is kinder
The counter argument is also true. Being left holding shares in a business where you have no control of its success is pretty awful too. There may not be a suitable buyer or the price would be distressed.
This would be the most stressful time of their lives and they’re lumbered with your business. Cash flows may become irregular as the company copes and they’re exposed to further downside.
For most families the superior outcome would be the wave of a magic wand - a large cash payout. This can be invested passively in an investment portfolio to secure their future. It’s liquid and gives them flexibility in life.
Life is full of surprise
We all feel full of energy and indestructible when we start off in business. I know I did. Yet less than ten years later, I found myself lying on the operating table with a brain surgeon and anaesthetist hovering over me.
As a patient it was actually very little fuss to fix a brain aneurism at age 40, but the anaesthetist sombrely did his job and discussed the risks. Responding, “I’m quite valuable dead” didn’t seem appropriate, but I drifted off to sleep knowing all was in order if I croaked it.
What is your company worth?
Insuring your shares for the right amount is a game of pin the tail on the donkey. There are valuation methods galore and they spit out a range of results. They’ll also become out of date as you grow.
Do take advice, but overlay that with practicality. Get a simple model in place to keep your insured value up to date. The multiple-method is one example. Many small businesses sell for three times earnings, some for far more. While there’s no sophistication to that, if it ends up being the method used for insurance, it’s better than no cover at all.
Your company can actually put any number it likes on your head and doesn’t have to pay the full amount out. You just need a side agreement in place that outlines a methodology for how your family’s shareholding will be paid.
Even if the value of the payout isn’t quite what you expected your business to be worth, it provides financial freedom for both sides and at a practical level you can’t put a price on that.
Insurance brokers, your accountant and lawyer can help your business put this type of protection in place.
Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.