Key Person Insurance is Essential for Business Owners

PLAYING RUSSIAN ROULETTE WITH BUSINESS OWNERSHIP

You have sacrificed a lot to build your business. You have put in the countless hours, taken that late night meeting, and flown numerous miles to close that deal. We have all deferred sleep to complete the proposal, negotiated that contract 'till exhaustion, or practiced the pitch until perfect.

Then why are you jeopardizing all that hard work (and valuation) by not financially protecting your efforts? For a lot less than you’ll likely spend on your next vacation, you can mitigate that risk and protect one of your most valuable assets…YOUR BUSINESS.

TRUE OR FALSE

True or False? A business should consider obtaining key person insurance once they achieve a certain valuation.

FALSE: What would the financial impact be to both the company and the surviving partner(s), if one of the key owners passed in the first few years? If the damage would be substantial, the answer is simple.

Waiting to protect business ownership interests until you've met a certain revenue level is like waiting until you go sky diving before you get life insurance.

True or False? Key Person insurance is only utilized upon the demise of a business partner.

FALSE: There are a variety of strategies utilizing corporate life insurance, and many available policies tailored for business use. Cash can often be taken out of a Permanent policy and used to compensate the departure (not death) of an owner. This assumes the policy is FUNDED CORRECTLY, and contains adequate cash value. Some of these policies have 100% cash value accessibility after a year, without the surrender restrictions typically associated with traditional Permanent Insurance. There are also some great corporate solutions that allow for the original insured owner to be changed for another executive, without triggering a new surrender schedule. New underwriting and taxation must be considered. However, these new business-specific policies offer outstanding insurance flexibility for companies. This is where the guidance of an experienced business insurance advisor is important.

True or False? Key Executive Insurance is too expensive in early phase companies because expenses need to be minimized.

FALSE: There are many affordable solutions for this type of insurance. Term Life insurance with a lower face amount can be used initially, to reduce the cost of the coverage.

Once the business expands and revenues increase, you can add additional coverage, or convert the Term Life policy to Permanent Life that has more flexibility and uses.

This strategy allows basic protection in the initial stages when the business is ramping up. When current valuation increases, the amount of insurance protection can be increased and tailored to the needs of the business. Need a complimentary, informal business valuation to determine how much coverage you need? Just ask us.

I was recently discussing this strategy with a good friend and investment fund manager, Hal Spice, CEO at Sente Capital Management and AquaO3. He was asking why 9 out of 10 new companies aren't utilizing this protection strategy. I honestly couldn't answer him. By the way, Hal writes an excellent blog, Private Equity Advice ala Hal Spice, geared toward the VC /Angel/Startup community.

Recommendations, Strategies and Tips

Strategy: If you are a multi-owner business, it is strongly advised that you have a buy-sell agreement created.  This document will set a predetermined value on the company, and will allow for less equity distribution hassles if an owner dies or leaves the company. For more on buy-sell agreements, please read In Defense of the Buy-Sell Agreement Part One & Part Two.

Make sure that the buy-sell agreement is properly funded with a corporate-owned, Permanent life insurance policy.

Term coverage can be used, but does NOT contain cash value. So this does not work with an executive who simply leaves the company.

Recommendation: Make sure you are filing your 101(j) paperwork annually. Failure to properly submit this paperwork could render the payout, on a business-owned life insurance policy, taxable. Your CPA can assist you with this.

Tip: It goes without saying that you should seek an insurance broker, well advised in Business Insurance Protection.

ARE YOU WAGERING THE PINK SLIP TO YOUR BUSINESS?

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