Insurance—Part II – Life Insurance For Business Partners
Our next posting will discuss life insurance, and in particular, some business uses of life insurance. Many successful entrepreneurs are so busy addressing the day-to-day operational challenges of their businesses that they never recognize the potential negative ramifications of an untimely death. Life insurance can be used in some creative ways to ameliorate this situation.
Business partners depend on each other in a multitude of ways. Perhaps, one partner excels at marketing and sales while the other partner keeps the financial and operational side of the business functioning. Depending on the complexity of a business, there could be multiple partners, with each one specializing in a critical area of the enterprise. Regardless of the nature and sophistication of the organization, they all share a common circumstance—an untimely death of a partner could have a devastating effect on the continued viability of the business as an on-going concern.
Another potential negative effect of a partner’s death is the possibility of new, unwanted business partners. The ownership interests of the deceased partner will generally pass through his/her estate and either a will or the state’s intestacy laws will determine the identity of the new partner(s). Sometimes, a deceased owner’s heirs will be a good fit but leaving this up to chance is indeed a risky proposition. Many previously successful businesses either failed or were forced into liquidation/sale by the incompatibility of founding partners and their former partner’s heir(s).
Life insurance is a tool that can address some of these circumstances. In the first dilemma, the remaining owners need to replace the expertise of the deceased partner. A “key person” life insurance policy can provide the funds to recruit, hire and train a replacement employee, restore lost profits and reassure customers that the business operations will continue. Either term or permanent insurance can be used to fund a key person insurance plan.
Life insurance can also be used to fund a “buy-sell” agreement which seeks to avoid the problems caused by an unwanted new partner. The “buy-sell” agreement is a legal contract that establishes a pre-determined price with the intent to purchase the assets of the business should one of the contract participants pre-decease the others. It can be used in connection with a sole proprietorship, a partnership of two or more partners as well as with the stockholders of a closed corporation. With a cross purchase plan, the partners purchase life insurance on the life or lives of the other partner(s). The death benefit is used to purchase the deceased person’s interest in the business from the heirs. With an entity plan, the business entity enters into the agreement which obligates it to purchase the deceased party’s share. The business purchases enough life insurance on each partner to fund the pre-determined buy-out price. By naming itself as the beneficiary, the business entity receives the death benefit tax free and has adequate funds to consummate the buy-out from the estate.