original post 12/2014, updated 3/2019
Not having business life insurance on a partner can create a devastating loss for a company. But, I don’t want to trivialize the need for personal life insurance. Not having a plan in place to patch the giant hole left when a breadwinner in a family dies is bad planning, and negligent, with one exception. There are families out there who struggle to make ends meet and budgeting even a small amount for life insurance is something that just can’t be done. You might be able to squeeze it in force, but if it is a monthly struggle it won’t stay in force and it becomes a double calamity when it lapses. Your family is then left without either the insurance or the money you squeezed from some other important budget item.
But, in a business, there are a couple of factors that make a the financial dynamics different from a family.
The Impact of Not Having Business Life Insurance on a Partner
From a life insurance perspective, one of the big differences between a personal life insurance policy and a business one is that the business failure due to an untimely death can not only impact your family, but also other principles in the business, banks, and employees can all take a hit. The problem that a business faces in the absence of life insurance is the same as a family, just magnified.
Probably the easiest of these to explain is in a partnership; two people have poured their life and resources into building a successful business and for the sake of simplicity we’ll say they are equal owners and that the valuation of the company is $2,000,000. If one of the partners dies, by law, the family of the deceased partner is due his half, $1,000,000. The laws understand that most businesses aren’t going to have that kind of cash laying around, so the alternative is that a member of the family can take over the deceased partner’s position in the company.
But in business planning there is a legal document that is called a buy/sell agreement. That agreement is funded by life insurance, a policy that each partner owns on the other. If one dies, the other receives the $1 million and by the legal agreement he cuts a company check to the widow or heirs for that amount, buying their share of the business. In the absence of life insurance funding that buy/sell, or not having a buy/sell at all, the money is still due. The likelihood that a bank is going to loan the surviving partner that much money is close to zero and it is highly unlikely that the financial adviser for the company would consider adding that much debt to be a prudent move.
Taking on a member of the family as a replacement partner is certainly an option, but highly unlikely to work out unless they have already been intimately involved in the business. And the last option, the one every successful business wants to avoid, is to liquidate the business and split the proceeds with the partner’s heirs.
No Business Life Insurance on a Partner is Just Bad Business
So, the one thing we can all agree on is that properly insured, most of us would claim to be insurance poor. But when business life insurance saves your company from liquidation, or is available as bank collateral when an opportunity arises, well, it’s apparent that “life insurance poor” is a phrase for whiners and not prudent business owners. For that matter, when I’ve delivered a life insurance death benefit check to a widow I have never, not once, had one complaint about being insurance poor.
Priorities! Responsibilities! Budget! What’s really important in your personal and business life. My personal goal with life insurance—to make sure that I leave my family and business in a financial position of not having to struggle to carry on—is prudent, reasonable and affordable.
If you have questions, have an impairment that makes life insurance hard to obtain, or need to look into a gap in your personal or business life insurance, call or email me directly. My name is Ed Hinerman. Let’s talk.