Life insurance is one of the foundational financial products that most business owners should consider having and maintaining for various reasons. The use of life insurance can help to protect your business, in terms of your largest investment, key employees from a premature death, and buy-sell agreements. In this article, I will provide you with information regarding these three areas to help understand the importance and best practices to implement a life insurance program that can meet a multitude of business needs for business owners or partners. If you have ever asked yourself why I need life insurance. As a business owner, it could be a wise decision to purchase a life insurance policy that specifically helps your business in the event of a premature death. 

Business Owners Largest Investment

Let's start off with the need for life insurance for business owners and their business. It isn’t uncommon for a business owner to deploy all of their resources and time into their business. Justifiably, your business provides you with income to support your lifestyle, support your family and creates jobs to support our economy. You likely depend on key talented employees to help run the business or even partners that each have unique roles to help the business be viable. An untimely premature death can create a disruption that can significantly impact your business production. 

When considering how life insurance should be designed to protect your business, you need to know the present value of your business. It is estimated that 98 percent of business owners don’t know the value of their business. Knowing what your business is worth is really important to help design and implement a life insurance program to help account for the present value. Obviously, no one knows what the future value of your business could be, but a snapshot of today's value is a great starting point. You can make adjustments in the future to adjust accordingly depending on the growth of your business. If your business valuation is negatively impacted, you could decrease your coverage as an option. If your business value is increasing, then considering another life insurance policy could be justifiable. The only caveat would be how insurable you are, because you would need to qualify for life insurance coverage in any situation. There are different methods to establish a valuation. I typically like to use Earning Before Interest, Taxes and Amortization termed EBITA and a reasonable multiple such as 2x as a starting point.

The purpose for life insurance as a business owner is to help replace the loss in a premature death and help your family or dependents maintain their lifestyle . As a business owner, you can think of life insurance as a standalone policy specifically for your business interests that will help your family transition. It isn’t unusual for a person to have multiple life insurance policies, meaning you can have a life insurance policy to help cover your personal obligations, such as debt, income replacement, college funding and income replacement; then have a policy specifically for the business. The final thought that I want to have you consider deals with the fact that as the business owner, you are the force behind the business and not the other way around. It wouldn’t be easy in many situations where someone could easily step into your place to run the business. In simple terms, you are your largest asset and having insurance on your life is more important than any material possession. 

Business Protection from the Loss of a Key Employee 

What are some life insurance considerations for business purposes when considering your talented key employees? Have you considered the impact that key employees make to the business? This includes you, partners and key personnel. As a business, life insurance can be implemented in several strategic ways to help the business and employees alike. Life insurance for key employees is the simplest strategy as a Key Employee program. You, as the business owner, partners, your sales team, operations or key skilled personnel with functions that help the business drive or maintain revenue. In the event of a premature death, how would your business be impacted with the loss of a key employee or partner? How long would it take to replace this talent and the loss of revenue that was helping the business thrive? 

The concept of Key Employee life insurance isn’t anything new and has been in use for several decades. Businesses of all sizes have used this strategy to help secure the business from the loss of a talented employee, if properly designed to help the employee’s family recover as well. Fortune 500 businesses, healthcare businesses, engineering firms, manufacturing companies, closely held family businesses and many other business types have utilized this strategy to help protect against the risk of a premature death of a key employee. 

Obviously, you would need to have the key employee know about this life insurance policy and the employee would need to qualify. The policy could also be designed to help the employee’s family as well, so it doesn’t feel so weird. Depending on the size of the business there are life insurance carriers that will take on the risk for multiple key employees, which is helpful in the case of a risk that would be uninsurable. There are a few different ways to structure this type of life insurance for key employee needs. It is usually best to work with a team that can help advise and recommend the best way to structure the key man life insurance program. You would work generally with a licensed financial advisor or life insurance agent that has experience or the support to review the needs of the business. 

Protecting Partners or Family Involved with Buy-Sell Agreement

The last concept for life insurance business needs relates to a buy-sell agreement.  When a business is privately held and whether it is owned by a single person or with partners, having a formal agreement in place with specific instructions regarding what will happen in the case of a premature death or even a disability, is incredibly important. Having a game plan and a strategy that helps eliminate potential problems or issues before they arise is a wise decision to help secure the vitality of your business. In terms of the use of life insurance to help the business in the event of a premature death, it can provide immediate cash that can help with a business succession strategy. The buy-sell can help with the succession to partners, family members or employees that might have an interest in continuing to run the business with little interference. Buy-sell planning is often overlooked by many business owners, but it is a vital part of your business operating plan and critical for your family’s financial security. 

As mentioned previously, the value of the business today is important when considering a buy-sell agreement. Setting a purchase price and terms of the payment in advance helps to eliminate confusion and helps the business keep operations in motion. It also is intended to help keep the interested parties formally involved and those that aren’t engaged in the business with a strategy to buy them out. Another benefit of having a formal buy-sell agreement plan helps to create a guaranteed market for your business interest. 

There are a few approaches to set up life insurance for the purposes of funding the buy-sell agreement when considering a premature death. When there is a situation that relates to a disability, that could be addressed with a disability insurance policy, which will be discussed in another article. The three common life insurance funding option types for a buy-sell agreement are an entity purchase agreement, a cross purchase agreement and a wait and see agreement. Each of these strategies has varying features and benefits that can be considered depending on the goals and desired results. 

In an entity purchase buy-sell agreement, it is designed for the business to purchase the life insurance and use the proceeds to buy out the selling owner. The entity can be corporation, partnership or an LLC and in the event upon a death, disability or separation, the business entity would purchase the business owner's interest with either the cash value or claim with the life insurance policy. Depending on the situation, having a formal agreement and utilizing the life insurance policy to help provide some options. As an example, if death or disability isn’t the situation causing the separation, but a change in interest or seeking other opportunities, the cash value could be used as a down payment and installment notes could be utilized. 

In a cross-purchase buy-sell agreement, the arrangement is drawn up between the owners with a contract that is outside of the business, but for the purpose to buy out the shares in the event of death, disability, retirement or simply succession amongst the owners. The cross-purchase buy-sell has each owner/partner purchase life insurance to help fund their obligations on each owner/partner’s lives. The benefit emphasizes a market for their interest at a fair price that helps business continue and helps remove family or other parties that don’t have anything to do with the viability of the business. 

The wait-and-see approach combines two options. The first option is for the business to purchase the business interest from the owner/partner. If the business isn’t in a position to acquire the business interest, then the second option would be for the co-owners/partners to have the purchase option. In the case that it is only one owner, there could be a formal process where a key employee could purchase the business. 

As you can see, there are different options where life insurance could be considered to help business owners protect their business from the risk of premature death, disability, or death of a key employee. A business owner could easily have a few policies that could address different needs of the business. Each life insurance policy would uniquely cover the loss of any of the risks discussed. As mentioned previously, your team of professionals would be a licensed financial advisor, life insurance agent and an attorney to help draw up the agreements, in some cases. Each professional would advise within their scope and address the needs of the business. 

Other considerations would be the type of coverage, qualifying and monitoring to make adjustments to the coverage as needed. Depending on the budget available, the life insurance coverage could be term or some type of permanent life insurance. Term life insurance generally is less expensive during young ages and becomes too expensive in older ages. Permanent life insurance has the ability to accumulate cash value, which if funded correctly, could have cash value accessible to help with different needs in the future. In terms of qualifying, if there are adverse health risks, lifestyle activities that might be considered dangerous could prevent the ability to qualify. Once a policy has been implemented, it is a matter of reviewing if the policy is adequate or should modifications be required. 

If all this seems too much, working with a financial advisor that is experienced in helping assess the needs of the business, the business owners personal goals and access to carriers that specialize in these products to position as efficiently as possible is your best decision. We can help with assessing these needs. Book a complimentary consultation to help explore life insurance for your business needs.