When thinking about business planning, most entrepreneurs and business owners focus on the strategic aspect of business. The fret about how to generate revenue, the best methods to market their business, issues around human resources and how to reign in costs and turn a profit. And while this makes sense, this narrow focus overlooks essential elements relevant to protecting the interests of both the business and its stakeholders.
In this post, we will look at other areas of running a business that require planning in order to ensure a business can avoid disruptions, including potential dissolution, when certain circumstances arise.
Loss of a Key Employee
A lot can go wrong when running a business. Arguably one of the most potentially disruptive events would be the loss of a key employee to death or disability. This can cause a loss in revenue, unsettle customers and other employees, and cost a lot in terms of replacement and training.
Enter key person life insurance.
Key man coverage can help provide financial protection and stability in the wake of a key employee’s death. This type of coverage helps to ensure that the business can continue to operate by providing liquidity to compensate for the loss of any revenue due to the employee loss while also covering the cost of hiring and training a replacement hire. That, in turn, helps provide stability that is reassuring to customers and employees alike.
In the event of the disability rather than the death of the employee, the company can use the cash value of the policy to recover costs from the employee’s absence. If the policy is structured properly, these distributions can be tax-free to the company.
Buy-Sell: Liquidity When You Need it Most
With any closely-held business, it is imperative that the shareholders have a plan to handle the exit, death or disability of any one of them. To address this concern, many business owners will enter into buy-sell agreements, either as part of a shareholders’ agreement or as a separate stand-alone agreement. However, these plans are only the first step and many business owners fail to contemplate and formalize how to fund the liabilities these agreements may create.
Without a plan in place, remaining shareholders will be forced to scramble to find the money to meet this liability, potentially relying on cash-on-hand, taking on loans, or even selling assets. Life insurance can be a better option by providing the liquidity to meet these obligations when needed while preventing disruptions to, or even the dissolution of, the business.
Using life insurance in this way generally takes one of two forms.
In a cross-purchase arrangement, each shareholder purchases a life insurance policy on the other shareholders, pays the requisite premiums, and makes themselves the beneficiary of the policies. At the death of a shareholder, the other shareholders collect the death benefit from their related policy and use the funds to purchase the shares of the deceased shareholder.
Furthermore, if the underlying policy is a cash value life insurance policy, that cash value can be used on the non-death departure of a shareholder to purchase their shares.
In a stock redemption plan, each shareholder enters into an agreement with the company to sell their interests in the business to the company upon certain events. The company then purchases a life insurance policy on the life of each shareholder. When a shareholder dies, their shares are redeemed by the company using the proceeds from the relevant policy.
And as described above in a cross-purchase plan, outside of the death of the shareholder, the company can use the cash value of a policy to purchase shares from a departing shareholder or even give the policy to such shareholder as payment for their interest.
Tying the Business to the Personal
Many business owners forget that their personal planning and their business planning are entwined. For example, how will your business succession planning impact your heirs, especially those who are not inheriting the business? How will your estate pay any taxes and settlement costs related to transferring the business?
With careful planning, a business owner can provide fair and equitable distribution of assets at their death and therefore minimize conflicts among family members and prevent a potential liquidation of business assets to meet estate tax obligations. This is another area where life insurance can help.
Proceeds from life insurance policies can be used by the estate and/or your heirs to cover any potential estate taxes or settlement costs related to a business owner’s death. And in the event where not all heirs will be inheriting the business, beneficiary designations can provide a means of estate equalization so that everyone feels taken care of and treated well.
Planning for Your Business
Just like in your personal life, proper planning is a key to success for your business. More than simply focusing on growth, it is imperative to also address issues that can impact the business and its stakeholders while recognizing the way your business impacts your personal planning.
By recognizing this necessity and acting accordingly, business owners can navigate uncertainty and grow their business with the certainty and confidence that they are ready for the unexpected.
At Robin Glen, we use our expertise in income and estate tax, private capital, and insurance analysis and design to create unique solutions that deliver impactful results for our clients and advisor partners.
As your life and the world changes, we are there every step of the way to ensure your planning evolves to always support you, your family, and your business.