The Small Business Owner’s Guide to Life Insurance
Have you ever stopped to think about what would happen to your business if you, one of your business partners, or one of your top performers were to pass away unexpectedly?
The commonalities between business and life are that they both move fast, and they both bring an essence of unpredictability. Take the time to address a commonly overlooked necessity for small business owners: life insurance.
Without the right life insurance coverage, your business is left extremely vulnerable in the event someone in your company passes away. This article is not meant to incite fear, anxiety, or depression. As an independent, unbiased life insurance agency committed to providing our clients with the protection they need for their families and businesses, it is our job to educate.
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Use this guide as a resource for adding extra layers of financial protection to your small business with life insurance.
Understanding Buy-Sell Agreements
For businesses with two or more owners, a buy-sell agreement creates a legally binding contract outlining how the assets and equity in a business will be divided if an owner dies. The agreement is created by purchasing life insurance policies for each owner.
When an owner in the agreement dies, their buy-sell life insurance payout provides funds for the remaining owners to pay the surviving family for the deceased owner’s share of the business.
This allows the business to continue operating normally, without liquidating or selling assets in order to pay the deceased owner’s family. It also keeps the owners’ families from having to get physically and/or emotionally involved in the business.
There are two main types of buy-sell agreements commonly used by businesses:
In a cross-purchase agreement, each owner purchases a life insurance policy on the other owner(s) with a face amount equal to their respective share of the net worth of the business.
A cross-purchase agreement allows the business to “buy out” a deceased owner’s interest from their surviving family, and the remaining owners can collectively put their best foot forward. With a cross purchase agreement, each owner purchases a policy on the other owner. Cross purchase agreements are ideal for businesses with two owners.
Stock Redemption Plan
In a stock redemption plan, partners or stockholders buy life insurance coverage equal to the respective shares of the other stockholders.
The premiums are paid by the company, and if a stockholder dies, the death benefit is used by the surviving stockholders to “buy out” the shares belonging to the deceased owner’s heir(s) at an agreed upon price. The deceased owner’s heir(s) receive immediate liquidity at fair market value for their business interest.
Stock redemption plans are usually utilized by businesses with three or more owners. This is because with a cross purchase agreement each owner must buy a policy on the other owner or owners. If your business has three owners, with a cross purchase agreement, your company would need to purchase six life insurance policies.
Determining the Value of Your Business
The value of the business can be calculated by using the book value, the market value, or the business’s capitalization of earnings.
Book Value: The book value is essentially a company’s net worth. Net worth is calculated by adding a company’s total assets and subtracting their liabilities.
Market Value: The market value of a business is determined by what a willing and knowledgeable buyer is willing to pay for the business.
Capitalization of Earnings: This value is determined by a company’s annual earnings. This formula is usually used by service-based businesses without a lot of physical assets.
Life insurance companies will usually use whichever valuation method is the highest to prevent the business and its owners from being underinsured.
To learn more about cross-purchase agreements and stock redemption plans, please see our previous article on life insurance for a buy-sell agreement.
Purchasing Additional Key Person Life Insurance
Every company in every industry has its “key” personnel besides the owners. For a restaurant, it might be the head chef. For a software company, it might be the chief technology officer. Key person life insurance is a means of protecting the business from the hardships that would follow if a key team member died.
In key person life insurance, the business is both the owner and the beneficiary of the policy. If the insured dies, the business receives the proceeds, which can help to negate lost revenue and/or provide the resources to hire and train a replacement.To calculate how much life insurance coverage to buy for a key person, first estimate how many years your business would likely suffer if they were to die unexpectedly. Then, multiply the number of years by the key person’s annual compensation (salary, commissions, benefits, and bonuses). If their compensation fluctuates, calculate an average from the past three years.
Life insurance companies will typically allow you to insure up to 10 or 15 times a key person’s total compensation. For most businesses, 5-10 years of the key person’s compensation will be sufficient and affordable.
To learn more about key person life insurance and how it can help protect your business, please read our guide here: “What is Key Person Life Insurance”
Securing Life Insurance for an SBA Loan
The U.S. Small Business Administration requires its borrowers to carry life insurance for the full amount of a loan. This is to protect not only the lender, but also the borrower’s family.
If you die before your SBA loan is repaid, your lender will receive the death benefit from your life insurance policy, allowing your business to continue functioning and preventing your family from having to shoulder the debt of your business loan.
A physician named Joel recently called us to purchase a $100,000 life insurance policy to cover his SBA loan. The SBA loan was to help him purchase a building so he could start his own practice. He needed to secure his life insurance quickly so he could close on his loan, as the loan would not be approved without the life insurance policy in place.
Since Joel is in excellent health at age 39, we were able to get his $100,000, 25-year policy approved in about 2 weeks. Once the loan closed, he decided to purchase an additional policy to protect his family.If you are on the clock to submit an SBA loan application, you might be alarmed to see that even an ideal applicant took 2 weeks to get approved for a policy. We can’t stress this enough: start shopping for life insurance as soon as you decide you are applying for an SBA loan.
Although there are “non-medical” policies (meaning no exam needed) that we can accelerate in a pinch, they are typically more expensive than policies that require a medical exam. Learn more about securing life insurance for an SBA loan here.
Pro Tip: Collateral Assignment
The balance of an SBA loan reduces over time as you make payments. Meanwhile, the balance of your term life insurance death benefit stays the same.
To prevent your lender from being overpaid in the event of your death, JRC can orchestrate what is called a collateral assignment to pay your lender only what they are owed so that the rest of the balance can be paid to your family.
Many agents at busy call centers don’t have the time or patience to recommend a collateral assignment, but since we are an independent agency with no daily sales quotas, we are able to be more thorough with your application.
Realizing the Importance of Life Insurance for Your Business
We’ll admit it, shopping for life insurance does not make the list of the most exciting things about owning a business. However, you can diffuse the anxiety and keep yourself engaged by viewing it as a valuable and meaningful investment—for you, your business partners, your employees, and your family.
Do not rush through the process of buying life insurance for your business. It’s important that you have your agent explain what a given policy means and what type of protection it provides your business. Oftentimes, business owners will buy several different types of business life insurance policies to address various needs.
Finding the Right Agent
An independent agency like JRC can save you time and money by shopping the market. In just a few minutes, we’ll be able to provide you with all of the affordable life insurance options available.
Unlike most local agents who represent one big-name company, we are able to shop multiple top-rated life insurance carriers. When you have more options, you have a better chance at better rates.
By representing more than 50 life insurance companies, we’re able to find our client’s the best life insurance options available.
We specialize with helping applicants that are considered to be a “high-risk” for life insurance, but we also work with carriers that offer the most aggressive rates available for applicants who are in excellent health. In fact, we can usually save our clients up to 35% on the cost of their life insurance coverage.Most importantly, our agents have multiple years of experience, and we’ve helped hundreds of business owners with their life insurance.
We are passionate, friendly, and committed to providing the impeccable service you deserve. Plus, as fellow entrepreneurs who left our day jobs in the insurance industry to start our own company, we understand your business life insurance needs.
Let the Googling stop here—call JRC toll-free today at 855-247-9555, or get a free instant quote online by clicking the map below.
Managing Partner and Co-founder
Cliff is a licensed life insurance agent and one of the owners of JRC Insurance Group. He has helped thousands of families of businesses with their life insurance needs since 2012 and specializes with applicants who are less than perfect health. In his spare time he enjoys spending time with family, traveling, and the great outdoors.