Any of us who have financial responsibilities should have life insurance to cover the need. I carry life insurance that would pay off rental property and our home if I died, leaving my wife with an income stream and no debt. I carry some more that would replace the need for her to work. She’s always wanted to do charity work and she would be free to do that without any concern about running out of money.
So what make’s the CEO of a company’s life insurance needs any different than mine or yours? They probably have personal needs that in a lot of ways mirror the average life insurance consumer, income replacement and mortgages, but it’s that responsibility thing that stretches their needs a bit further. What I’ve talk about so far would fall under the personal life insurance category. CEO’s, executives in many businesses and partners in business need to look to business life insurance or business purposes of life insurance to cover their responsibility to employees, partners and stockholders.
Probably the simplest way to explain business life insurance is through the concept of a buy/sell agreement in a partnership. For the sake of ease we’ll make it a 50/50 partnership with a business valuation of $1,000,000, making each partner’s ownership in the business $500,000. Now understand that if a partner in a business dies, his family, whether that’s a wife or children have every legal right to that half of the business. That can be accomplished in a number of ways, but there’s really only one that will ensure the business stays intact and able to move forward easily for the surviving partner. But first, the other less palatable ways to remedy the ownership issue.
1. A member of members of the deceased partner’s family can actually take his or her place in the company. They have the right in the absence of a buyout to do their best to fill the empty shoes and continue the income stream and retain their half of the partnership. There’s probably 100 reasons this won’t work, but the obvious is that very few spouses know the job well enough to just step in and take over. The truth is it would be a very rare situation if that worked. Most families just get by having a basic knowledge of the company and would be an absolute disaster as a partner.
2. The partners could have set aside part of their income as a way to settle this kind of a challenge, but the likelihood that a $1,000,000 business is going to have $500,000 saved up is, well, a little far fetched. Even if they have some saved up, it is only a start toward buying out the other family. Start first by knowing what you have already.
3.If the surviving partner can’t work with the family in the business then they are bound by law to buy the family out in order to keep them out. Keep in mind here that legal partnerships are far easier to resolve than just a couple of guys that have been working together a long time and call themselves partners but have never had legal status given to that. In a legal partnership if the surviving partner doesn’t want the other family in the business and doesn’t have the money to purchase the other half of the business, often the business has to borrow the money or has to be liquidated in order to meet the obligation. Borrowing half of the worth of a business isn’t going to fly with any bankers I know and liquidating the business means the two families will be splitting pennies on the dollar of what the business was worth in its’ working mode.
So comes the buy/sell agreement funded by business life insurance. Each partner takes out a life insurance policy on the other for an agreed upon amount (it can be adjusted as the business grows), in this case $500,000 each. When a partner dies the other partner receives the $500,000 death benefit and through the legal buy/sell document they are bound to buy the deceased partner’s share from the widow or family. The result is the family gets the full value they are due and the business is left intact, cash healthy and ready to move on.
Bottom line. The absence of a succession plan for a business is ignoring the responsibility each partner has to their partner and their families. It’s not hard to set up and generally doesn’t cost that much for insurance, so for the same pennies on the dollar that they might realize liquidating the business, they buy life insurance and everything works out. If you have any questions or have a specific situation that you would like to get quotes on, call or email me directly. My name is Ed Hinerman. Let’s talk.