The small business sale is often nuanced and complex
by Ian PersaudMr. Persaud is a Senior Partner with the firm Phoenix Private Wealth working through Equitable Advisors. Visit www.equitable.com.
Life insurance is critical contingency capital, and it’s especially important for small business owners who have employees and business partners relying on them.
While your clients have likely considered life insurance before, there are important and nuanced considerations when it comes to how life insurance can be used to protect a business and a family. Life insurance is critical but talking about it can be overwhelming for some advisors’ clients, so it’s important to know how to approach the conversation and ensure their needs are being met.
Whether your client has an existing policy or is looking to expand their coverage, these are the top best practices to keep in mind.
Start With A Team
As with any game plan, you need a team. Implementing a life insurance plan for small business owners can be more nuanced and more complex than personal life insurance, which is why a team-based approach is the best approach. Work with your clients to construct a team comprised of a financial advisor, CPA and an attorney to make sure that financial, legal and tax needs are accounted for.
Working with a team of legal and financial advisors enables an impartial entity to guide the client through the process and mitigate some of the emotions that come up in life insurance conversations. This team can help clients establish a legal framework that outside parties must abide by, which reduces conflict between business partners and family members in the long run.
Understand The Options & The Benefits
Life insurance is a proactive plan that mitigates potential financial disruption for your family and for your business. If an owner passes away, it can have a significant, negative financial impact on a business and family, so one of the benefits of life insurance is the ability to ensure business continuity. To ensure business continuity, small business owners can establish a buy-sell agreement with their life insurance policy.
Here’s how it works: As some small business owners share business ownership, they can construct a cross-purchase agreement with their life insurance that ensures co-owners are able to “buyout” the deceased’s portion of the business should a death occur. The life insurance policy with a buy-sell agreement enables the owners or partners to receive the death benefit if one owner/partner passes away.
It can then be used to purchase the deceased owner’s shares – a scenario that may not be financially possible without a life insurance policy. Small business owners should remember that life insurance policies are important for individuals inside and outside of leadership roles. High-performing employees contribute to a company’s culture and their revenue streams.
However, along with the emotional hardship of losing an integral team member, a keyperson’s untimely death can have significant, negative financial impact on a business. While difficult to discuss with an employee, keyperson insurance is available to help lessen the financial impact of an untimely death. With keyperson insurance, the business becomes the beneficiary of the life insurance policy – helping to offset revenue loss.
In addition to the business continuity benefits, life insurance policies can be used to shelter small business owners’ assets. For example, life insurance has significant tax benefits, such as tax-free distributions and tax-deferred growth, that shelters the assets from being depleted by taxes. Death benefits are typically distributed tax free. Tax-deferred growth also enables assets to compound over time helping to build value. It can also shelter assets in the event that litigation is brought against a small business owner. In some states, life insurance has cash-value but cannot be seized in the event of a lawsuit that results in a civil penalty.
Calculate a Small Business Owner’s Needs
First, it starts with family. Personal life insurance is a key financial piece to have in place for the family if things don’t go as planned. This is imperative for small business owners and entrepreneurs who may not have traditional employee benefits, like a 401(K) in place, so that their families have financial reserves in case of a tragedy. Dealing with death is an-already emotionally draining and grief-laden time and having finances secured and safeguarded takes one worry off of the family.
While it varies greatly from family to family and person to person, small business owners should have personal life insurance that covers the potential income loss and interim business expenses (e.g. existing debt or overhead costs) until a transition can take place. This is why life insurance is considered contingency capital; it’s there if something goes wrong, so that your family can stay on track financially – no matter the business expenses.
Life insurance is also a critical part of legacy planning and building generational wealth. If a tragedy occurs, it ensures your family is able to continue with legacy planning, and ultimately generational wealth building. Without life insurance, families can be left with business expenses and income loss that is difficult to overcome and can drain resources for generations to come.
In addition to ensuring your family is protected with a traditional life insurance policy, life insurance can be purchased to protect your business and its employees. In this scenario, life insurance is based on the value of the company that the owner or CEO feels the company is worth, and ultimately what the owner or CEO is generating in revenue. For example, if an owner contributes to 20 percent of the business’ revenue, then a life insurance policy to cover that 20 percent would be an appropriate approach. Taking a quantitative approach to calculating your life insurance removes any gray area for what someone may or may not think the owner owes.
Small business owners typically consider more robust policies to ensure both their family and business is covered in case of tragedy.
Implement Life Insurance as an Employee Benefit
Life insurance is an essential employee benefit that small business owners should make available to full-time employees and staff. Small business owners should be prepared to communicate with their employees about their options and the benefits. Most importantly, keep it simple. Employees and clients want to know: what is going to happen when I purchase this policy, what is the upfront and long-term cost, and what are the long-term/short-term benefits? Working with a financial advisor and your benefits provider can help streamline these conversations and ensure employees feel supported during their benefit selection process.
It’s also important to dispel certain misconceptions about life insurance policies. For example, many people are hesitant to purchase a policy because they feel their premium will be too high or they may not qualify. You don’t have to be in the best shape of your life to qualify for life insurance, and increasingly, life insurance providers are implementing accelerated, remote underwriting as a result of COVID-19. This technology-driven change is making life insurance easier to purchase and more accessible.
What’s Next for Your Small Business Owner Client?
Small business owners carry an immense amount of financial responsibility for both their business and their family, and as such, they cannot be overprepared for the unexpected. A comprehensive life insurance policy is a fundamental part of their own financial plan, and the financial plan of their employees. Talking with an advisor is the best place to start, so advisors should be prepared and understand the complexities of life insurance for small business owners to ensure they are properly protected.