Life Insurance in Business

Life insurance is generally thought of only with regard to protecting the financial well-being of individuals and their families. But life insurance can play a major role in the financial stability of businesses as well. When analyzed, it’s clear that a business has the same basic insurance need as that of an individual: protection against premature death and the delivery of cash exactly when it’s required. This need for ready funds relates to the disposition of a business interest upon the death of a key person of that business.

Businesses are generally organized in one of three ways: a sole proprietorship, a partnership, or a corporation. The death of a proprietor, partner, or a key working stockholder would require the disposition of his or her business interest, just as any other asset. This can often result in the restructuring of the business, its sale or even liquidation. Unfortunately, the difference between a company's sale and its liquidation can be quite dramatic, with the sale usually resulting in the family receiving a fair market value for the business interest. Liquidation, on the other hand, is a forced sale that may bring only a small percentage of the business' true value. In some situations liquidation of the business is mandated by law; but it is, nonetheless, the least desirable method of disposing of the deceased's asset. In order to avoid such an outcome, the sale or retention of the business would require proper planning and implementation of business agreements, a willing and competent successor or buyer, and sufficient cash with which to implement the transfer. Let's look at how the sole proprietor can protect his or her business interest with the strategic use of life insurance.

A sole proprietorship is an unincorporated form of business whereby an individual, utilizing his or her own special talents and abilities, owns and manages a business. Even though this type of organization may have several employees, it’s the sole proprietor who is generally directly responsible for the success of the business. This individual has unlimited liability with regard to the business operation; creditors can claim both the owner's business as well as personal assets. When the sole proprietor dies the business also dies, and with it a source (many times the only one) of income for the family. Unless there's been adequate planning beforehand, the business may have to be liquidated for a fraction of its value in order to pay estate settlement expenses.

Life insurance can be used to solve the problems created by the death of the sole proprietor. It can fund a business continuation agreement (also known as a buy-sell agreement) by providing necessary cash with which to keep the business operating until it can be sold at a fair market value for the benefit of the deceased’s family. Life insurance can also be used to provide funds for a competent employee or other qualified person to purchase the business from the surviving family members.

In Part 2 of this article series we'll look at how life insurance can be used for the protection of partnerships and corporations.