How the insurance industry can support SMEs

Adv. Yanush Singh, National Business Development Manager at Sanlam

The personal estates of business owners and the assets and liabilities of their businesses are inextricably intertwined. As a result, limiting personal liability is easier said than done and it is not enough to establish a juristic person, for example a company, through which to trade.  In order to successfully separate the affairs of businesses from the personal affairs of their owners, entrepreneurs need various business assurance solutions.

Many entrepreneurs choose to conduct business through a form of business enterprise such as a company. Companies are juristic persons that have their own legal personas, separate from those of their shareholders. The corporate veil affords entrepreneurs protection and demarcates a clear boundary between the assets and liabilities of their companies and their personal estates. For example, should a company become unable to service its debts, the creditor will have recourse against the company (which could result in the attachment of the company’s assets) but not against the entrepreneur, personally.  Ultimately, the intention of these entrepreneurs is to distance themselves from the liabilities of their companies, thereby mitigating the risks of doing business.

Business owners and creditors have conflicting objectives. If a financial institution extends credit to a company and the company defaults, its credit risk will be reduced if it also has a right of recourse against the shareholders in their personal capacities. This is especially if the company has insufficient assets to secure the debt. When financing businesses, lenders, therefore, enter into agreements with shareholders, in terms of which they require shareholders to stand surety for the debts of the business.  These suretyship agreements typically give the creditor the right to sue any of the sureties in their personal capacity (without first suing the company) for the full amount of the loan. This could mean that a single, minority shareholder foots the entire bill, after which they will be saddled with the unenviable task of trying to recover from their co-shareholders. And so, with the stroke of a pen, the efforts of entrepreneurs to limit personal liability, are undermined.

Financial institutions are not the only source of funding. In many cases, the shareholders themselves invest in the business and these investments are reflected on the balance sheet as credit loan accounts. This means there is an obligation on companies to repay these debts to the shareholders at some stage. When a shareholder with a credit loan account dies, in order to wind up their estate, their executor must recover the loan amount in full from the company. If the company does not have access to sufficient cash to repay the debt, the death of the shareholder has the unintended effect of bankrupting the company. To add insult to injury, if the executor is unable to recover the investment, it will be the deceased’s heirs that are detrimentally affected. Credit loan accounts are a classic example of how personal estates impact businesses and vice versa.

The deceased shareholder’s heirs also inherit their shareholding in the business. As most South Africans don’t have valid wills, shareholdings often devolve intestate, meaning that in most cases a deceased’s spouse and children end up with shares in the business. As one can no doubt imagine, this usually comes as quite a surprise to the remaining shareholders. Surprise soon gives way to disillusionment when the remaining shareholders realise they cannot compel the family to sell the shares to them and, even if they could, they do not have the funds to purchase the shares.

Mitigating the risks of doing business

Intermediaries play a pivotal role in protecting the financial wellbeing of their entrepreneur clients by supporting them throughout their journey towards financial confidence. This may include the implementation of business assurance solutions to minimise the financial impact of these unfortunate consequences.  For example, contingent liability cover aims to ensure that the debts of the business are repaid on the death or disability of a surety, protecting the personal estates of the shareholders. Credit loan account cover provides the business with funding required to repay debts owed to shareholders in the event of their death or disability.

Lastly, buy and sell arrangements aim to ensure that the remaining shareholders retain control of the business and that the heirs of the deceased shareholder are adequately compensated.