Business Life Insurance: Protecting Your Company's Future

Business life insurance is a crucial aspect of business planning that helps protect the company, employees, business partners, and family. It is designed to provide financial security and continuity for the business in the event of the owner's or a key person's death or disability. This type of insurance can be structured in various ways, including buy-sell agreements, key person coverage, and individual life insurance. Buy-sell agreements, also known as buyout agreements, are contracts between co-owners that allow the surviving owner to buy the deceased owner's share. Key person life insurance provides financial protection in the event of the death of an essential employee, helping to cover lost revenue and recruitment costs. Individual life insurance for small business owners ensures that loved ones have the financial means to keep the business operating or pay off debts. Business life insurance also plays a role in loan requirements, employee benefits, and tax advantages. Overall, it is an important tool for business owners to protect their legacy and ensure the long-term growth and stability of their company.

Business continuity after the death of the owner

The death of a business owner can have a significant impact on the continuity of the business. It can result in a quick sale or even closure of the business if the deceased owner's family is left without sufficient financial resources to sustain operations and manage debts. Business life insurance can play a crucial role in mitigating risks and protecting the business in the event of the owner's death.

Key Person or Key Man Insurance

Key person insurance, also known as key man insurance, is a type of coverage that focuses on the business owner or other critical individuals within the company. The main consideration is whether the absence of this person would cause significant financial harm to the company. If so, key person insurance can provide a financial cushion to cover the transition period and avoid lost revenue. The death benefit from this insurance can be used to recruit, hire, and train a replacement, ensuring continuity for employees, customers, and creditors.

Buy-Sell or Cross-Purchase Agreement

Buy-sell agreements are another essential tool for maintaining business continuity. These policies ensure that each business partner has a life insurance policy that provides funds for the surviving partner(s) to buy out the deceased owner's share of the business. This simplifies the buyout process, as the shares are purchased at a previously agreed-upon value, ensuring prompt and fair compensation for the deceased owner's heirs.

Individual Life Insurance for Small Business Owners

Individual life insurance policies can also play a role in business continuity. In the event of the owner's death, the policy can provide immediate cash to keep the business operating. This money can be used to pay bills, fund salaries, or even recruit a new key employee to help run the business.

Lines of Credit and Loan Requirements

Life insurance can also be a requirement when seeking loans or financing for a small business. Lenders and creditors often mandate that the owner has life insurance to protect their interests and ensure the repayment of outstanding debts in the event of the owner's death.

Business Agreement and Planning

It is crucial to structure your business agreement correctly and seek the guidance of a qualified attorney and business accountant. They can help create a written business agreement with life insurance as the funding vehicle and identify the key roles that require protection for the business's success.

Buy-sell agreements

A buy-sell agreement is a contract between business partners that ensures the continuity of the business in the event of the death of one of the partners. It is also known as a buyout agreement and is funded by a life insurance policy.

There are two main types of buy-sell agreements: a cross-purchase plan and an entity purchase, or stock redemption, plan. In a cross-purchase plan, each business owner buys a life insurance policy on each of the other owners. When an owner dies, the remaining owners use the payout from the life insurance policy to buy the deceased owner's share of the business. This type of agreement may avoid lender or creditor restrictions imposed on a company's cash flow.

In an entity purchase, or stock redemption, plan, each employee-owner agrees to sell their interest in the business to the company itself. The business buys life insurance policies on the lives of each owner, pays the premiums, and is the beneficiary of the policy. When an employee-owner dies, their share of the company passes to the heirs of their estate, and the business can use the policy's death benefit to buy the interest from the estate. This type of agreement provides centralized management of the policies and collects death benefits.

A buy-sell agreement can also be structured as a redemption agreement or a cross-purchase agreement by the surviving owners, or it can be a hybrid of the two. In a redemption agreement, the entity will be the buyer of the decedent's interests in the entity. The entity will own the life insurance policies and receive the proceeds, which it will use to buy the interests of the deceased owner from their personal representative. A cross-purchase agreement, on the other hand, allows the surviving business owners to purchase the deceased owner's interest in the entity. The business owners own the policies insuring each other's lives and receive the proceeds directly, which they use to buy the shares from the deceased owner's personal representative.

Key person life insurance

The company is the beneficiary of the policy and pays the premiums. In the event of the key person's death, the company receives a death benefit. This money can be used to cover the costs of recruiting, hiring, and training a replacement, as well as offsetting lost revenue during the transition period. It can also be used to pay off debts, distribute money to investors, provide severance benefits to employees, and close the business down in an orderly manner if the company decides to cease operations.

Key person insurance is also available as disability coverage in case the individual is incapacitated and no longer able to work. This can help safeguard a small business if an imperative employee becomes disabled.

When deciding how much key person insurance to purchase, companies should consider the percentage of the key person's contribution to the company's bottom line, as well as their current salary, which is often multiplied by a factor of five to seven. The cost of the insurance will depend on whether the company buys a term life or permanent life policy, with term life being significantly cheaper.

Lenders may also mandate that businesses purchase key person insurance to receive financing.

Loan requirements

Lenders often require life insurance as collateral for business loans to ensure repayment if the business owner dies unexpectedly. This is especially the case for small businesses, which may only have one or a few employees. In such cases, the business is tied to an individual, and the lender may require a guarantee of repayment.

The Small Business Administration (SBA) requires a life insurance policy to secure a small business loan when the small business is closely connected to one or more business owners. According to the SBA, the "lender must determine if the viability of the business is tied to an individual or individuals. In these situations, the lender must require life insurance".

The amount and type of collateral available to repay the loan will determine the appropriate amount of life insurance. Most SBA lenders will require your policy's death benefit to be equal to or greater than the current amount of your outstanding loan balance. The term length of your coverage should match or be longer than the duration of the SBA loan.

The cost of life insurance for business loans depends on factors like the type of policy, death benefit amount, and the individual's health condition. Younger and healthier individuals may only need a telephone interview to get coverage, while older individuals might have to undergo a medical examination.

When selecting a business loan policy, you must decide between an affordable term life insurance or a more expensive permanent life insurance option. Term life insurance is the most popular policy for self-employed people to purchase to cover their business loans. Term life insurance plans offer a level death benefit with premiums guaranteed for between 10 and 30 years.

To qualify as loan collateral, the life insurance policy must usually be for the same amount and length of time as the loan. The insurance policy can be used as collateral, ensuring the loan will still be repaid if a small business owner dies.

Collateral Assignment

A collateral assignment is the most common provision in small-company lending and is familiar to insurers and banks. It is a conditional assignment appointing a lender as the primary beneficiary of a benefit to use as collateral for a loan. If the borrower is unable to pay, the lender can cash in the insurance policy and recover what is owed.

The bank will be the beneficiary on a collateral assignment form when a life insurance policy for an SBA loan is in place. The collateral assignment form must be filled out by every party involved, including the insured, the lender, and the insurance company.

Tips for Buying Life Insurance for SBA Loans

• Avoid buying a life insurance policy before understanding your bank's loan requirements for the death benefit and term duration.
• Buy the face amount required by the lender to ensure that your loan application is approved.
• Buy the proper term length to cover your loan for its entire duration.
• Provide a proper collateral assignment form before the loan is approved.
• If you pay off your loan sooner than expected, you can cancel the policy without facing penalties.

Employee benefits

Business life insurance can be used as an employee benefit in several ways. Firstly, it can be offered as part of an employee's benefits package, with the employer paying the policy premium for supplemental term life insurance. This type of insurance often provides coverage equal to one year's salary and allows the employee to choose a spouse, child, or loved one as the beneficiary.

Employers can also enhance this baseline coverage by offering permanent policies as part of an executive package. This type of insurance can be a critical tool in an executive's retirement planning and can help retain employees by providing additional financial support for the employee's family after their passing.

Additionally, business life insurance can be used to secure a line of credit or loan for a company. Lenders and creditors often require the owner to have life insurance before closing on a loan as a protective measure for all parties. The life insurance policy serves as a financial safeguard, ensuring the repayment of outstanding debts and protecting the interests of both the lender and the borrower's family in the event of the borrower's passing.

Frequently asked questions