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Key Person Life Insurance

Many small businesses are highly dependent on the presence of a key employee or small group of employees for the ongoing operation of the business. It may be an owner, partner or some other important person. Protecting the business against the untimely death of that person with some type of life insurance policy can be wise. In fact, some lenders may require such an arrangement.

Here are some questions to help determine if you may need that type of protection:

  • What would happen if one of your key employees were to die?
  • Would your business cease to operate?
  • How would your operations change?
  • Is there another to take that person's place?
  • How much would it cost to hire another to fill the void?

If answering those questions raises red flags, you may want to consider buying some life insurance on that key employee to have funds available to help run the company until a replacement is found or another resolution is determined. The best policy could be relatively inexpensive term life insurance. The business would be the policy owner and beneficiary and would pay the premiums. If the person dies, the company receives the death benefits and can then decide on a future course of action.

Using Life Insurance as Part of a Buy/Sell Agreement

Buy/sell agreements control what happens to an ownership interest in the event of the death or disability of one of the major owners of the business. They can be structured so that on the death of an owner, the business buys back his interest or the remaining owners buy the interest. In most cases, buy/sell agreements include some valuation guidelines for the business.

Many companies use life insurance as a means to fund these types of agreements. For instance, if the business is valued at $3 million and one owner has a one third stake in the business, the business may buy a $1 million term life policy. The proceeds could be used to buy the deceased owner's shares on his death. Another option would be for each owner to buy policies on the lives of the other owners. There are some special tax rules that apply to corporate ownership of life insurance policies. If you are considering this type of arrangement, be sure to seek qualified legal advice.