Business owners spend years building revenue, teams, and reputation. Very few have a written answer to a simple question: what happens to this company if I, or my partner, die or become disabled?
Two tools answer that question: key person insurance and a funded buy-sell agreement.
Key person insurance
Key person insurance is a life insurance policy the business owns on someone whose loss would hurt the company. The business pays the premium and is the beneficiary.
If that person dies, the benefit goes to the business, which can use it to:
- Replace lost revenue while the company adjusts
- Recruit and train a replacement
- Reassure lenders, clients, and employees
- Pay down business debt
The key person is often an owner, but it can also be a top salesperson, a lead engineer, or anyone the business would struggle to replace.
Buy-sell agreements
A buy-sell agreement is a legal contract between business owners. It sets out what happens to an owner's share if they die, become disabled, or leave: who buys it, at what price, and how it gets paid for.
How life insurance funds it
An agreement is only as good as the money behind it. Life insurance is a common way to fund a buyout because it pays out exactly when the money is needed.
- Cross-purchase: each owner owns a policy on the other owners and uses the proceeds to buy the deceased owner's share.
- Entity redemption: the business owns a policy on each owner and buys back the share itself.
Each structure has different tax and ownership consequences. Your attorney and CPA should help pick the right one for your business.
Don't forget disability
During the working years, the odds of a long-term disability are often higher than the odds of dying. A disability buyout policy can fund the purchase of a disabled owner's share, so the business isn't stuck supporting a partner who can no longer work in it.
Keep it current
The biggest mistake is setting this up once and never looking at it again. As the business grows, the value of each owner's share grows too. Review the valuation and the coverage regularly so the funding matches what the business is actually worth.
Questions to ask
- Who in this business would be hardest to replace?
- Do we have a written buy-sell agreement, and when was it last updated?
- How is the buyout price set, and is it funded?
- Does our plan cover disability as well as death?