When you own a small business, your family members aren’t the only people depending on you. Your death could be a disaster for your employees and partners, and it could destroy the company you worked so hard to build.
That’s the short explanation of why you need life insurance. But there’s much more you need to know.
Sometimes Your family depends on your business’ income to survive. Further, you may have taken out loans backed by your family’s assets to start or grow the business. But your family members might not be equipped to take over the business if you die. They might also be unable to sell it easily. This could leave them without income or even in a position to lose their home, if that’s collateral for a business loan.
Life Happens, an insurance industry group, explains it this way: “When the family is forced to sell the business quickly, they may have to sell at a discount or during market conditions that make the business less attractive. In other cases, the business may be worth very little without the proprietor or partner.”
If you have partners, your family might be unable to step into your role, and your partners might be unable to quickly buy out your share, Life Happens notes. In this case, your family might have to help run the business during a stressful time or be forced to sell off the company. Finally, your business may rely on key employees whose deaths would seriously dent earnings or operations.
In each of these scenarios, life insurance could save your small business or protect your family. Each involves a different sort of policy.
A personal life insurance policy would help your family pay off any business debt and cover living expenses after your death. Your family would then have time to figure out what to do with the business.
If your business has multiple owners, you can combine life insurance policies on each partner with a buy-sell agreement. The agreement stipulates that on the death of a partner, the remaining partners can buy out the surviving family’s share at a previously agreed price. The life insurance pays for the buyout.
Finally, key person insurance is life insurance that protects against the death of a critically important employee. In the event of death, the insurance pays the owner or owners of the business.
1. Resolving Debt
Imagine a situation where one of your employees holds the formula for a proprietary beverage. As a company you’ve decided to keep the formula a secret as you wait to have your patent receive a pending status. Because of the competitive nature of your industry, you know very well that if the secret formula was to get out it would mean certain death of any future prospects for your company. And so without great fanfare, it is decided that very few people should be kept in the loop. At the time this looks like a very wise idea. No?
If something were to happen to the person holding the formula (key person) and somehow the formula didn’t receive a pending status from the United States Patent and Trademark Office, how would you deal with the situation?
2. Continuance of Operations
The creation of proprietary products means that a company needs to hire personnel with a specialized skill set. Even then, more training may be required for employees that will play a key role in the development of your product or service. Needless to say, this is usually a resource-intensive endeavor. Scarce resources mean that training will not be available for everyone so a company may find itself inadvertently placing all of its eggs in one basket.
So how can key person life insurance help you in the unfortunate event that your key person dies? The money from the payout can be used to recruit and train capable individuals to continue from where the last man left off. Instead of having to cease operations your company would slow down its operations at most.
3. Improves Chances of Getting VC Financing
Most, but not all, venture capitalist (VC) firms require key person life insurancewhen issuing the first round of financing. This convinces the VC that their investment will be safe in the event that the key person is no longer in a capacity to run the firm’s operations. The key person life insurance is usually taken out on the CEO, CTO, or both.
This allows a VC to be able to recoup part of their investment should something happen.
4. Morale Booster
If the company ends up taking out a key person life insurance policy on an individual or number of people, it means that the company sees them as a crucial part of the company. It is a tacit acknowledgment of their importance.
Instead of viewing themselves as a liability to the company in the case of unforeseen circumstances, such individuals may get a morale boost from their recognition as a key part of the company. By extension, this may lead to their happiness in the workplace.
According to research conducted by Warwick University, happy employees are 12% more productive than their counterparts. Decreased productivity is estimated to cost US companies between $450 – $550 billion dollars on an annual basis.
The argument, in this case, is that people who are involved in startups are already passionate about their projects. By taking out a key man policy on them and showing them how important they are to the company can only enforce their resolve to succeed.
5. Cost Free for The Employee
Premiums are paid by the company, which is also the beneficiary and receives payouts in the event that the key person dies. Since the key man has no financial obligations towards the policy, they have no reason to object to such a policy being taken out on them as it’s not a burden to them or any of their dependents.
It also might serve as a morale booster to know that the company is incurring additional costs due to the crucial role they play in the company.
Sample Key Person Life Insurance Rates
Below quotes are priced per month based on a 45 year old male at the Preferred health class. Rates shown are not an official offer of insurance and require qualification.
Policy Face Amount10-Year20-Year30-YearUL to Age 100$500,000$37$62$108$303
Below quotes are priced per month based on a 45 year old female at the Preferred health class. Rates shown are not an official offer of insurance and require qualification.
Policy Face Amount10-Year20-Year30-YearUL to Age 100$500,000$32$48
6. No Long Term Obligation
Keyman life insurance policies were conceived in a long gone era when most employees stayed with the same company until retirement. This, of course, is no longer the case. According to CompData surveys, voluntary employee turnover in 2015 was almost 11.6%. One-third of new hires quit their job after 6 months.
In the event that a key person decides to leave a company before the end of the cover period for key person life insurance, the company would NOT want to be in the tough situation of being forced to make premium payments on an employee no longer working there. Fortunately, this is not a concern.
The company that owns the key man policy can cancel and quit making payments at any time, for any reason.
On the flip side, the company gets the benefit of locking in the rates for the duration of the policy they choose. For example, if a 20-year level term policy is purchased, the rates cannot rise for 20 years.
It’s good to be in the position of the business owner with keyman life insurance. The company is not locked in or obligated to continue however the insurance carrier is.
Under Section 37 (1) of the Income Tax Act, any company purchasing keyman insurance for its employee may claim a deduction for any premium payments as a business expense.
The benefits also extend to the payouts. However, that is contingent upon a number of conditions being met:
The employee has to be notified in writing that their employer intends on taking a life insurance policy on them and the maximum amount applied for on their life
The employee is also required to give consent in writing that the employer has the option of keeping the policy in force even after they cease being employees
The employee must be notified in writing that the employer will be the beneficiary of all or part of the proceeds.
Unfortunately, if these conditions are not met prior to the issuance of the keyman life insurance policy, the proceeds will not be tax exempt.
Not all keyman life insurance policies mature after a person’s death. Sometimes a partial payout will be made to cover healthcare costs of the insured. This includes:
If the insured suffers from invasive cancer, a first heart attack, bypass surgery, first angioplasty, stroke etc, depending on the policy the insurance company may pay up to $25,000 in cash to the company which owns the policy.
In the event that the key man suffers from a chronic disease that incapacitates them requiring the need for assisted living or home health care, the insurance company can pay up to $250,000 depending on the policy.
9. Stock Buyouts
If the key man was a major shareholder in the company, the surviving partner(s) can use the life insurance proceeds to buy back stock from the estate or the key man’s heirs. This is often beneficial to everyone involved. It allows the surviving shareholders to retain full control of the company and the key man’s estate or heirs are well compensated.
10. Employee Incentive
If whole life insurance is purchased on the key man, the cash value that builds can be given to the key man when he leaves or to his estate if he’s deceased. Since this grows over time, it’s an extra incentive for the key man to remain with the company.