Selling a Business – How Insurance Reduces Risk

It’s dead winter.

You wouldn’t head out on a family road trip without checking your car and local weather forecast would you?

There are many actions available to reduce the risks when embarking on the buying or selling of a business. Adequate protection through insurance is high on our checklist.

The majority of our transactions involve the seller financing a significant portion of the purchase price. Most also involve a training program to equip the new owner to operate the business successfully and ensure a smooth transition.

We build these into the agreement. But what if the buyer or the seller were to get ill or die? Insurance can mitigate the risks for both.

Protecting the loan

If you’re the seller, meet with a wealth planner who is a licensed insurance broker; insist as a condition of sale that the buyer put in place adequate protection for the loan you’re making to them. An experienced broker can find the most cost-effective plan to meet the needs and obligations of the buyer AND protect you, the seller.

Let’s backtrack slightly to mention another precaution. A seller that is financing the buyer would be prudent to apply the same diligence as any financial institution lending money. This can include checking references – former employers, employees, clients, suppliers, bankers and so on. Verifying the skills, competence, integrity and reliability of the purchaser is important. Credit checks, Personal Property Security Act (PPSA) searches and criminal history checks through the Canadian Police Information Centre (CPIC) are, of course, essential.

Our seller should insist upon a critical illness policy on the buyer with sufficient benefits to cover the payments on the loan they’ve providing.

A judicious buyer will want more than this as the seller is not their only obligation.

The plan should continue in place to protect the buyer and their family; the buyer should be meeting with a knowledgeable broker to establish requirements. Adding sufficient life insurance to pay off the outstanding debt obligations, with the seller as a named beneficiary, can cover off the risk of the purchaser getting ill or dying. Setting up this type of policy is much cheaper than the loan insurance provided by banks, is more flexible, and may provide significant tax benefits to the purchaser.

We mentioned earlier that most of our transactions include a training/transition program. Sellers should obtain insurance to make sure that the buyer receives sufficient proceeds to enable them to survive in the business if the seller can’t deliver on the program.

Insurance policies can also be an effective means of removing excess cash from the business prior to selling the business without being required to give up a substantial portion to the tax man. It is important to meet with a wealth planner who is a licensed insurance broker before selling your business and you should be insisting as a condition of sale that the buyer also meet with them to put in place adequate protection for your loan to the buyer.

Protecting against liability and business interruption

The security for the loan that the seller provides to the buyer includes a personal guarantee. While it may include the shares of the business being held in escrow until the loan is paid, it almost always includes the assets of the business being used to secure the loan.

A prudent seller will put a commercial insurance policy in place to protect these assets against fire, flood, theft and other losses. Experienced insurance brokers can help you determine what’s most cost-effective.

Sellers should do this before selling a business and insist as a condition of the sale that the insurance be maintained and that they be a named beneficiary. Business interruption insurance should be part of that protection. Most of us put an insurance policy in place and then forget about it. It’s recommended that you revisit this with an experienced commercial broker each year as your needs, risks and assets change.

Liability coverage is also essential. As a lender, you do not want the business wiped out because the purchaser failed to put in place adequate liability insurance. Put the coverage in place prior to the sale and insist that it be maintained as a condition of the loan.

As a prudent business owner, you should have these protections in place whether you are selling the business or not. Insurance reduces risk.

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Gregory Kells
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