Many people tend to only think of family when it comes to life insurance, but if you co-own a business or are a partner in one, ensuring its financial future is important. Just as you want to make sure your family will be taken care of should anything happen to you, you want to make sure that your business will be in safe hands and can continue without interruption due to the loss of one partner. Term life insurance that covers each business partner is the key.
But to understand why you need term life insurance, you first you need to understand what a buy-sell agreement is.
In the most basic of terms, you/your partner are obligated to buy and the heirs are obligated to sell— hence, the buy-sell agreement.
This type of coverage is ideal for business partners, since the loss of one of you often means significant loss for the business as far as its operations are concerned. A buy-sell agreement in a life insurance policy ensures that ownership of the business can transition smoothly. It is essentially a contract between business partners in which you agree (are obligated) to purchase the business share left behind by whomever passes away first. In this case, the deceased partner’s heirs are also under obligation to sell this interest. Your business attorney would help set up this agreement.
As basic as this agreement essentially is, you may be wondering by now what happens if you can’t exactly afford to buy your partner’s share after they pass. This is where term life insurance comes in.
Term life insurance gets its name from the fact that the insurance policy is for a predetermined time period, although it often can be extended or converted to permanent coverage. Term life insurance ensures that your beneficiaries will get a substantial death benefit (a payout) in the event that you pass away during this set time period. You pay an annual rate for this coverage, and this usually consists of monthly installments that are usually fixed for the term length of the policy – anywhere between 10 to 30 years. Overall, term life insurance is considered the simplest, most manageable life insurance option.
For most businesses, term life insurance is the smartest choice when thinking about the future. You and your business partner can choose the term you want, as well as set the price at which your shares will be bought and sold. This doesn’t have to be a fixed price; the buy/sell agreement can include a formula to value the business, such as a multiple of sales.
Premiums for term life insurance often add up to being lower than the cost of a partner’s share, and the death benefit payout is typically free of income tax. These benefits will immediately provide the surviving partner with the funds they need to purchase the deceased partner’s share of the business.
Let’s look at an example. Say George is currently the co-owner of a successful restaurant with his friend and business partner, Steve. The two of them decide to make their future significantly more secure by purchasing term life insurance policies with a buy-sell agreement. Both men are 40 and are healthy, nonsmokers, so they will likely receive the following offers for $250,000 20 year term policies (an amount that is estimated to cover the cost of a share and its interest).
SBLI: $17.84 per month
Banner Life: $18.38 per month
Protective Life: $18.79 per month
Transamerica: $20.78 per month
American General: $21.29 per month
MetLife: $21.74 per month
Now, say both men decide to go with Banner Life and each pay that rate for 15 years, when George is tragically killed in a car accident. Steve then gets the insurance policy payout and uses it to pay George’s heirs (in this case, his children) for his late partner’s half of the business. The heirs are then unburdened by having it, and they get a nice lump sum as payment. Meanwhile, Steve is able to continue running the restaurant or even sell it, now that he has complete control over it and doesn’t have to worry about the heirs coming after it.
To learn more about buy-sell coverage and the different types, here's a great resource.
You should also consider key man life insurance to help keep the business running and be able to hire for your partners roles. Most companies with a buy-sell in place, also have key person coverage to protect their business.