Being in my third decade of life insurance sales, I am still amazed how many partnership businesses don’t think about life insurance. At least some go to the trouble of hiring a good attorney to write the partnership contract. The attorney almost always suggests key man life insurance or a buy sell life insurance for this agreement. The partners then, by my experience, both procrastinate and don’t start the process. Or out of fear, believe the business cannot afford it at start up. This is a huge mistake. Let me tell you why.
First, the definition of key man life insurance or key woman life insurance is a life insurance policy usually a large term life insurance policy that covers an important or key person in the business. This is not necessarily used in partnerships but it can be. The business has an individual that is so important to the business that upon sudden death the business would suffer. Usually the business is the beneficiary. This money is used to keep the business going while recruiting a replacement. This term is misused a lot with partnerships.
A Buy Sell life insurance policy by definition is a policy that is used in a partnership agreement that upon sudden death of a partner the beneficiary, usually said partner’s family is “bought out” of their portion of the business. Most often the amount of life insurance purchased should equal a partner’s share of the total worth of the business. For example, if two partners own a business with a value of $1,000,000 then each partner should carry $500,000 in life insurance to “buy out” the other partner. This way the partner’s family is compensated for their value of the business and the remaining partner or partners now own the business.
The down side to not having buy sell life insurance in place is that the suddenly deceased business partner’s family now owns the partners share of the business. You may absolutely love your partner and his family. But do you really want your partner’s spouse and children running the business with you? Without something like buy sell life insurance in place, your new business partner will be their spouse.
Finally, how affordable is buy sell life insurance? In most cases the best option is just 10 year term life insurance policy which is the most affordable of term insurance. My thoughts behind that are the business is growing and changing through the years. If a two person partnership is worth $500,000 this year and both partners purchase $250,000 10 year term life insurance each that would be sufficient. If in 6 years the business is now worth $1,000,000, the $250,000 in proceeds would not “buy out” a partners family and the business would have to payout additional $250,000 cash to the family. I recommend having a good experienced life insurance broker involved to review your policy on an annual basis to avoid a conflict.
“Keep away from people who belittle your ambitions. Small people always do that, but the really great make you feel that you, too, can become great.” – Mark Twain
Image by at David Castillo Dominici www.freedigitalphotos.net
Tim Wilhoit is owner/principal of Your Friend 4 Life Insurance Agency in Nashville, TN. He is a family man, father of 3, entrepreneur, insurance agent, life insurance broker, salesman, sales trainer, recruiter, public speaker, blogger and team leader with over 26 years of experience in sales and marketing in the insurance and beverage industries.
Don’t let your small business die with you. Good move Tim, great advice.
I see this more then just about any other problem in my b to b marketing. Doctors Dentist Lawyers Vets and other white coller occupations simply forget to buy the protection they need to keep the business going. Also need to consider disability insurance as well
Disability is one of the major reasons for the close of a business. Buy out disability insurance is important and can keep both the biz and individual solvent.
Also a agreement needs to be looked at every year just to make sure that all things are well compared to the growth of the partnership.
Jason,
That is a very good point about how important the disability insurance as well as the buy sell life insurance protection. Thank you for sharing that point.
Tim, great article! Great advice!
My former business partner and I carried a buy-sell, and considering all of the time, effort, and work that god into building a business it just makes good sense to cover your bases with a good agreement already in place.
Fortunately, we never had to exercise ours, but one thing for certain, as much as we adored each others wives, there was no way we wanted to be in business with them. 😉
Spence, thank you for your kind words and sharing your story. No one thinks it will ever happen to them or their partner. However, there are multiple funerals held everyday.
Isn’t that the truth.
Thanks, a very good read…
Tim,
I think this is a very important topic and many business partners do not realize the importance of funding a buy sell agreement with life insurance. What do you think of using a permanent life policy for a buy sell agreement and having it double as an executive bonus? Is it best to have separate policies for these two items? I know that life insurance for executive bonus is usually owned by the insured but paid for by the employer, but I don’t see why a company owned policy wouldn’t work. What are your thoughts?
Peter, that is absolutely a good idea. In some cases it makes total sense on the executive bonus side. We are seeing more and more of IUL used this way for the tax advantages for retirement. I still believe in most cases using a combination with term life for affordability and it is easier to add as the business grows and values increase. Thank you for sharing, excellent point.
Peter you touch on one of the other planning risks, particularly when you have quite a difference in age between shareholders, succession planning. Use of a suitable product for buy/sell in time could be used to fund the succession of the exiting, usually older, shareholder at point of retirement and ease the burden on the remaining shareholders funds. Another way to extract value with an insurance approach for all concerned without the need for bodily harm and death.
Do not forget to add Disability Buy Sell policies,great majority have never heard of this.
Thanks Tim – Sound advice! I know many Brokers who do not have Buy Sell Life Insurance in place for their own operations and who overlook the advice to current and potential Clients!
Great insight. Thank you Tim!
Tim, great topic. A related issue was highlighted in the February 12th WR Newswire of the AALU Washington Report. They cited the “Selzer v. Dunn” case. A buy/sell agreement was created by the attorney but never executed by the parties. Life Insurance was obtained to fund the buy/sell but never tied to the buy/sell. As anticipated, a huge problem developed when one of the partners passed away. Buy/Sell Agreement + Life Insurance = Less Heartache and Headaches.
Scott what an excellent example of not having the correct partnership agreement in place along with buy sell life insurance when the partnership is first formed. What heartache and headaches all parties must be going though. Tragic, thank you for sharing this!