Life insurance for business: When do you need it?
A proper business life insurance strategy is an essential part of the success of an organization. Learn how life insurance can be for everything from recruiting to cash flow.
Information courtesy of USAA Life Insurance Company and USAA Life Insurance Company of New York
Owning a small business can be hard. There's a lot to keep you busy: growing profits, keeping track of the competition, hiring and retaining employees.
Many small business owners view their companies as a legacy. After all, they've put a lot of sweat, tears, time and money into the business. There's little time to worry about whether it will live on if they die unexpectedly.
If this sounds familiar, life insurance structured with the business in mind can help. More than a nice benefit to offer employees, life insurance can help protect the business you've worked so hard to build.
Why is life insurance important for small businesses?
Many small businesses have one or two owners, with each bringing different skills and experience to the company. If one of these owners dies and their insight and expertise are lost, what affect will that have on the business?
As you weigh whether your business could survive without you or one of your partners, ask yourself the following questions:
- Can the business continue without this person?
- Is there money available to help replace the person?
- Can any surviving family members run the business? Do they have the right skills and experience?
- Do surviving family members want to run the business?
- How do any surviving partners feel about other family members joining the business?
- Is there money available to buy back business shares from a deceased partner's heirs?
After your business has become successful, you should revisit similar questions for key employees:
- Could the company survive without them?
- How long would it take to replace that individual?
- How much will it cost?
Life insurance can help cover some of those losses, providing much-needed funds to help your business survive.
How can life insurance help protect your business?
When running a business, it's important to structure your business agreement correctly. Partnering with a qualified attorney and business accountant is the first step.
They can help create a written business agreement with life insurance as the funding vehicle. In this process they can also help identify the key roles your business will need to protect for success.
There are four common instances to use life insurance as a part of business agreements.
- Key person or key man insurance
- Buy-sell or cross-purchase agreement
- Purchase agreement
- Stock purchase
1. Key person or key man insurance
This insurance covers the life of the business's owner, top executive or other critical individual. The main qualifier: Would this person's absence cause major financial harm to the company? If the answer is yes, key person life insurance might be a good idea. The company is usually the policy's beneficiary and also pays the premiums.
A key person is important to a small business that relies on their unique experience. Replacing such an individual with someone of a similar skillset is expensive and time-consuming. A life insurance death benefit gives the business a financial cushion to cover the transition and avoid lost revenue.
2. Buy-sell or cross-purchase agreement
These policies ensure each business partner has a life insurance policy that provides funds for the surviving partner to buy out the deceased owner's share of the business. Each partner, the business or a trust owns the policy.
Payout from this life insurance policy can help the surviving partner maintain ownership of the business in the event of the unexpected death of the other partner. It simplifies the buyout of the deceased partner's shares at a previously agreed upon value. This also ensures that the deceased owners' heirs will be fairly and promptly compensated for their share of the business.
3. Purchase agreement
This type of policy is like a cross-purchase agreement, but it's used by sole proprietors. This agreement arranges for another person or business, like a competitor, to buy the business when or if the owner dies.
That person or business then would take out a life insurance policy on the sole proprietor, using the death benefit from that policy to fund the purchase of the business from the sole proprietor's heirs.
4. Stock purchase
With incorporated businesses, the owners will use a life insurance policy to fund the purchase of stock from a deceased owner's estate.
Often, the owners or shareholders might have an agreement that restricts the rights of the owners to transfer their stocks or shares. Usually, such agreements give the other owner the right to buy the interests or shares in case of their partner's unexpected death.
What types of life insurance are available?
Business owners have options when it comes to their company's life insurance. The right policy depends on the circumstances. Most key-person insurance policies are term life insurance. Buy-sell agreements are typically permanent life insurance. Other situations could require a combination of both types of policies.
Although permanent life insurance is usually more expensive than term, it offers a cash value component that can be an asset for the business.
The most vital component of any business life insurance policy is a clear and legally binding agreement on how the death benefit will be used by the surviving partner or owner. An attorney can help you draft the agreement with the help of a business accountant.
If you're looking for ways to protect your business beyond life insurance, check out small business insurance.