Business Partners: Life Insurance For Security And Peace

Life insurance is an important consideration for business partners. It can protect the business and the family of the deceased in the event of their death. Business partners can take out life insurance policies on each other as part of a buy-sell agreement, which provides the funds to buy out the deceased partner's stake in the company. This ensures the business can continue operating and provides financial security for the deceased's family. Key person life insurance is another option, which covers the business if a crucial member dies. It can help maintain the business's value and cover the costs of recruiting and training a replacement.

Buy-sell agreements and life insurance

Buy-sell agreements are a crucial aspect of business continuity planning, especially when multiple partners are involved in the management and operations of the company. These agreements, also known as buyout agreements or business prenups, outline a clear framework for the transition of ownership in the event of a partner's death, retirement, or departure from the business.

Types of Buy-Sell Agreements

There are two common types of buy-sell agreements:

• Cross-Purchase Agreement: In this type of agreement, each partner purchases a life insurance policy on the lives of the other partners. When a partner dies, the surviving partners use the death benefit from the life insurance policy to buy the deceased partner's share of the business from their estate. This ensures stability and continuity for the company, as the remaining partners can maintain control without the need to sell the company or bring in new ownership.
• Entity Purchase Agreement (also known as a Redemption Agreement): In this case, the business itself buys a life insurance policy on each owner. When an owner dies, the business uses the death benefit to purchase their shares from the estate. This type of agreement ensures that the business has the necessary funds to buy back the shares, protecting the company from potential financial risks.

Benefits of Buy-Sell Agreements with Life Insurance

Buy-sell agreements that include life insurance offer several advantages:

• Business Continuity: The primary benefit is ensuring the continuity of the business by providing a smooth transition of ownership. The agreement prevents outsiders from gaining control of the business and allows the remaining partners to maintain stability and control.
• Protection from Legal Battles: Without a buy-sell agreement, the shares of a deceased partner may automatically pass to their spouse or family members, who may decide to keep them or sell them. A buy-sell agreement with life insurance ensures that the remaining partners have the necessary funds to purchase the shares, avoiding potential legal disputes over control of the business.
• Equitable Transfer of Wealth: These agreements promote a fair and orderly transfer of wealth, ownership, and management. They provide money to create a fair market value exchange and guarantee heirs a buyer for assets they may not know how to manage.
• Tax Advantages: The life insurance proceeds from a buy-sell agreement may offer tax benefits by avoiding the Corporate Alternative Minimum Tax (AMT) since the policy is owned by an individual rather than a C Corporation.
• Protection from Creditors: The policies and cash values associated with the life insurance component of a buy-sell agreement are typically protected from the creditors of the business.

Considerations and Drawbacks

While buy-sell agreements offer significant benefits, there are also some considerations and potential drawbacks to keep in mind:

• Cost: Engaging a lawyer to draft a comprehensive buy-sell agreement can be expensive, especially for new or small businesses.
• Flexibility: The agreement may make it more challenging for business owners to sell their interests to parties not mentioned in the agreement. Relationships and business needs can change over time, and the purchase price stipulated in the agreement may become outdated, valuing the business stake too high or too low compared to the current market conditions.
• Complexity: Buy-sell agreements can be complex, especially when multiple partners are involved. It is essential to work with legal and financial professionals experienced in this area to ensure the agreement aligns with the specific needs and dynamics of the business.

Key person life insurance

The loss of certain key employees can have a devastating impact on an organisation. Therefore, many companies take out key person insurance to provide a critical financial cushion that can help stabilise the business while leadership finds a new way forward.

The business owns the policy, but the employee has to consent. The company purchases a life insurance policy on certain employees, pays the premiums, and is the beneficiary of the policy. In the event of the person's death, the company receives the policy's death benefit.

One of the most common reasons businesses take out this kind of coverage is because they are applying for a business loan or other financing, and the lender or investor requires this type of life insurance as collateral. Other reasons include:

• If the business is named after the owner or other key person.
• If the company is significantly linked to a person's reputation, skillset, or financial viability, and that person's loss would jeopardise the business.
• If the loss of the key person could significantly impact the company's sales or finances.
• If the business is a partnership, and each partner wants funds to buy out the other's shares in case of an untimely death.

When these life insurance policies are required as collateral for business loans, the benefit amount needs to be at least enough to repay the loan. In other situations, the coverage amount can be harder to determine. You need to think about the financial impact the key employee's death would have on the business, including the cost of recruiting and hiring a replacement, operational disruption costs, and slower time to market.

Types of Policies

There are two main types of key person life insurance policies: term life insurance and permanent life insurance. Term life insurance is more affordable, but coverage is temporary and generally ranges from one year to 30 years. Permanent life insurance has higher premiums but can provide additional benefits, such as building cash value that the business can borrow against or withdraw from for future expenses.

Group life insurance

The typical group policy is for term life insurance, often renewable each year with a company's open-enrollment process. This is in contrast to whole life insurance, which is permanent, has higher premiums and death benefits, and is the most popular type of life insurance. With group life insurance, the employer or organisation purchasing the policy retains the master contract. Employees who elect coverage through the group policy usually receive a certificate of coverage, which is needed to provide to a subsequent insurance company if an individual leaves the company or organisation and terminates their coverage.

Term life insurance

Life insurance is an important consideration for business partners. It can protect the business and the partners' families in the event of an owner's death.

The amount of coverage provided by a term life insurance policy depends on the specific policy and the insured's needs. It is important to consider both personal and business expenses when deciding on the amount of coverage. Factors such as dependents, future education costs, and business debts should be taken into account.

Business partners can also include life insurance as part of a buy-sell agreement. In this case, each partner purchases a life insurance policy on the other partner(s). If one owner passes away, the remaining owner(s) use the death benefit to buy the deceased owner's company shares. This ensures stability for the company and allows it to continue functioning with minimal financial impact.

When considering term life insurance, business owners should shop around and get quotes from multiple companies. Working with an agent or broker can help navigate the process and find the best coverage for their specific needs.

Permanent life insurance

Whole life insurance policies offer peace of mind to business owners because they guarantee a payout to beneficiaries regardless of when the policyholder dies. The premiums for whole life policies remain the same and a portion of the premium is set aside to build the cash value of the policy. Over time, as the policyholder continues to pay the premium, the cash value of the policy increases. Depending on the policy, the policyholder may take out a policy loan or withdraw cash value funds.

Whole life insurance is one of three types of permanent life insurance policies. The other two are universal and variable universal life insurance. Universal life insurance allows the policyholder to adjust the death benefit and premium amount. Variable universal life insurance is similar, but the cash value of the policy can be invested in the stock market. These policies offer tax advantages and diversification of investments, making them appealing to business owners with pass-through corporations or other entities that can hold assets.

Frequently asked questions