Business Protection and Risk Strategies


October 25, 2013


Every medical practice with two or more owners needs to have the right strategies in place if one of the owners leaves due to premature death, total and permanent disability or a traumatic illness.

As the practice provides its owners with regular income, capital, security, superannuation and retirement flexibility, protecting the exiting owner’s needs, in addition to the remaining owner, is one of the most important risks a medical practice needs to consider. If the correct insurance and legal agreements are not put in place, some of the problems that can occur are:

  • The exiting business owner (or, in the case of death, his/her estate) can make demands on the practice for it to be wound up, to be paid out for his/her interest in the business, or for the repayment of loan balances. The estate may also insist on immediate and direct involvement in the control and operation of the practice.
  • In the event of total and permanent disability or one of the owners suffering a trauma event (e.g. cancer), there may be uncertainty over the likelihood of the business owner recovering or ever returning to work. The continuing business owners may then end up doing all of the work, but are still forced to legally release income and profits to the non working owner.

What is a business succession agreement?

Two or more parties share the ownership of a medical practice, e.g. they (or their trust, spouse, etc) each own shares in the practice. Should one business principal die or become disabled, the continuing principals want to ensure they are able to purchase the outgoing principal’s interest, and the outgoing principal wants to ensure his/her estate is paid a fair value for the interest.

Using Insurance to fund business succession

The most cost effective and efficient strategy is to use insurance policies to compensate the existing business owner in the event of death or disability. Importantly, insurance is not the only way to fund a business succession strategy but, as mentioned, it is the most certain and cost effective process as the only other options are for the remaining business owners to take out sufficient loans to fund the exiting owner’s share value. If loans are taken out, this can create delays in transfer, additional costs to pay interest on the loan, the business may not be able to get the full loan value and, hence, a smooth transition is not achieved.

How does the process work?

A legal agreement known as a buy/sell or shareholders document ensures the shares are transferred to the remaining business owners via put and call options.

In relation to the insurance component, each business owner owns a life and disability policy on their own life for the value of their shares. As an example, there is a medical practice valued at $2MIL with two owners that own the practice 50/50, hence each of their share/value is worth $1MIL. If Owner 1 passes away, the life insurance policy pays the value of his/her shares ($1MIL) directly to his/her estate or nominated beneficiary.

The end result is Owner 1’s estate/beneficiary has been paid the value of his/her shares/practice value via insurance proceeds which ensures they are properly compensated. The remaining business owner receives the exiting owner’s shares/ownership via the legal agreement; hence Owner 2 is properly compensated as they can continue the practice in an efficient way without Owner 1’s estate/beneficiary intervening in the operations of the practice. This strategy provides the best outcome for all parties concerned and the ongoing operations of the business.

Care needs to be taken in regards to policy ownership to ensure tax issues/liabilities are minimized in the event of a claim. A risk/insurance specialist is required in addition to a qualified solicitor and account to achieve the right outcome for all parties involved.

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