What Does Insurance Have To Do With Business Succession?

Remember the first time you considered building your own business? It was probably an exciting moment. Did you imagine a hole-in-the-wall bar or diner? Or did you imagine an expansive retail empire? Whatever you imagined, the likelihood of achieving those goals depended entirely on your motivation, and, of course, that you made the right choices at the right time.

Most people who start their own business are in it for the long haul — and they want that business to survive and thrive long after they die. Business succession planning is one of several ways to achieve that. The concept is simple, and it works much like planning your estate.

For example, most people know they should have a last will and testament in case they die unexpectedly (even though many don’t follow through). These documents determine how our assets are divided when we die, and who gets what. Business succession planning works the same way, except for your business. How will you pass control when you retire, sustain a disability, or die? Like all legal affairs, you will need a business attorney to walk you through each step and make sure the right documents are in order.

Many business owners who plan for the future will want to consider a life insurance policy. Most people believe this type of insurance provides a benefit to those you leave behind — primarily so they can pay for funeral expenditures or unpaid debt. But life insurance can be used in other ways. 

For the sake of our discussion, we’ll talk about partnership buy-sell agreements, family buy-sell agreements, and then how life insurance factors into either one.

This type of buy and sell agreement is a covenant between business partners that determines what happens to a partner’s share of the business upon his or her death. In general, the agreement results in the sale of that share to the surviving partner.

A family buy-sell agreement works the same way. In general, though, the goal is to pass the deceased’s share of the business to surviving family members so the business continues to be passed down from one generation to the next. Talk about pressure, right?

There are both advantages and disadvantages to using a life insurance policy to complete business succession. 

Here are the pros. When you own a life insurance policy, the death benefits are almost always non-taxable. They are also paid relatively fast to reduce pressure on a family. They aren’t paid in installments. The benefits can be used by a surviving partner (or family member) to pay for lost shares. 

Here are the cons. Life insurance policies cost money, thereby increasing a business’s expenses. Because the policy needs to be big enough for a partner to pay for the deceased’s share of the business, the premiums will be more than you might expect. They could become even more expensive as a person’s health declines due to injury, old age, or disease. And you might need a lot of coverage depending on how big the business is.