Partnership Insurance

Few events can cause more turmoil in a small business than the death of an owner. Besides the personal loss, there’s the practical loss of a key asset and the question of ownership going forward.

A life insurance payout can provide operating cash to get the company through a tough time. It can also help the surviving owners buy a late partner’s share from his or her heirs. Arrangements like this are often set in a buy-sell agreement, one of the most important documents in any business partnership.

Buy-sell agreements are like prenups. They’re legal contracts between business co-owners, detailing how the ownership transfers if one partner dies, becomes disabled or leaves the business.

Creating an agreement is one step in the succession planning process. Funding is the other. That’s where life insurance comes in.

Creating a business succession plan - business partners who aren’t related “should have a buy-sell agreement from day one. . Without such an agreement, you could wind up in business with your partner’s spouse or kids. And without a life insurance policy, you might have difficulty funding the agreement. For example, the loss of one owner could make it hard to qualify for a loan.

Choosing term or perm - Pick a life insurance policy based on the length of time you’ll need coverage and your budget. Term life provides coverage for a certain period — such as 10, 20 or 30 years — and pays out if the insured person dies within the policy’s term.

Permanent life insurance — such as whole, universal or variable life — costs many times more than term policies. This is because the policy covers the insured’s entire lifetime, and features a savings account, which grows tax-deferred. Once enough cash value is built up, the owner can borrow from it or terminate the policy for the surrender value.

Buying the life insurance policy - There are two main ways to structure a life insurance purchase that funds a buy-sell agreement:

      Cross-purchase: Each partner buys a policy on the
      other and names him or herself as the  
      beneficiary. If one dies, the surviving partner uses
      the life insurance death benefit to purchase the 
      late partner’s share of the business.

      Entity-redemption plan: The business purchases
      separate life insurance policies on the partners
      and is the beneficiary of the policy. If one partner dies, the business can use the death benefit to
      purchase the partner’s share. An entity redemption plan makes sense if there are more than a few
      partners.

Deciding how much life insurance to buy - Business partners should buy more insurance than they think they might need. Remember, the death of a partner will hit the business hard. Revenues may take a hit until you find a replacement. You’ll need money not only to buy out the partner’s share, but also to hold you over until the business can regroup.