Life Insurance for Your Business

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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As a business owner, you probably already own more insurance policies than you ever imagined you would. In addition to your personal auto, home, disability, health, and life insurance, your business also needs insuring: liability, equipment, vehicles, and any number of policies are often strict necessities. Heck, you may even have a pet insurance policy.

However none of these forms of insurance actually protect the life of your business. Following are two forms of life insurance that can be used to protect your business when the going gets tough.

1. Buy-Sell Agreement (Shareholder’s Agreement)

Within your shareholder’s agreement is likely a clause that dictates what happens when an owner dies (in the case of multi-owner companies). Their shares will need to be bequeathed, or purchased by the company or remaining owners.

In most cases the shares are purchased, at which point the company/surviving owners will require the cash to complete the transaction. The problem is that most companies and their owners don't have that sort of cash lying around.

Enter in life insurance to the rescue. There are many ways to structure life insurance to fund buy-sell agreement terms, depending on the nature of the business and ownership structure. One of the more effective methods is for every owner to be insured for the approximate value of their shares. Each policy is owned and paid for by either the company or the other owners, and the other owners are the direct beneficiaries.

Thus, if an owner dies, their life insurance policy pays out to the surviving owners, who can in turn use the money to buy the deceased’s shares. That money goes to the deceased owner’s estate or surviving family, as if they had simply sold their share of the business.

It gets better. Depending on the structure of the life insurance policy and nature of the business, the premiums may be tax deductible. And as with most life insurance, the insurance proceeds are also tax-free.

Without this insurance in place, the surviving owners may not have the money available to make such a purchase.

2. Key-Man Insurance (Key Person Insurance)

A company’s best assets are the key employees. These are the people who have unsurpassed sales records, special expertise, or an extensive inside knowledge with a level of responsibility that is hard to replace. Without these assets – these key “men” – the business could suffer substantially.  If you are applying for a substantial business loan, the bank may look for it as a reassurance that the company can weather the loss of a key person and still make loan payments.

Key-man insurance insures the lives of these select star employees. The company does it all: it owns the policy, pays for the premiums, and is the sole beneficiary. The money is used to help the company cope with the loss of key employees while a suitable replacement is found.

Who do you choose to insure? Obviously you won’t be blatantly insuring every decent employee to walk through the door. Typical key-man insurance selections include active owners, employees with solid bonds to major customers, and those with specific knowledge or expertise that is hard to replace.

It should be noted that an active business owner could potentially have both key-man and buy-sell life insurance on their lives. The buy-sell insurance would provide other owners with the ability to buy out their share of the company, and the key-man insurance would keep the company books in the black while day-to-day operations reel from the loss of an active owner.

The trickiest part of the deal is determining how much life insurance to purchase on each key person. Some factors to consider include:

• How much net profit does the employee’s work result in?
• How much would it cost to replace them? (Consider expenses such as recruitment fees and training time.)
• How much is the company willing and able to pay for key-man insurance?

Company expenditures as a result of losing a key person can come in the form of reduced sales, fees to find and train new people, and even losing accounts to the competition during a period of reduced service capacity.

With key-man life insurance the financial pain of the loss can be avoided.  

As a business owner and vital player in the company operations, your business is the fruit of your continued hard work and resources. But unexpected circumstances out of your control can lead to your business ultimately collapsing. So if your business is a substantial part of your world, it is worth getting the proper insurance in place.