Business Ownership and Key Man Insurance
When a co-owner dies unexpectedly, it can cause a business to go into a tailspin. Depending on the role of this deceased party, the company’s operations may even stop, drastically reducing its revenue. In short, the unfortunate effect could be total chaos. To complicate matters even further, the owner’s surviving spouse might try to take on this leadership position, which may create additional tension between the other owners.
There is a good strategy to help you avoid the possibility of financial devastation. It’s called key man insurance and its use can ensure that you maintain more control over your company in case of an owner’s sudden death.
Simply stated, your company purchases a life insurance policy on an owner that names the company as the beneficiary when the insured owner passes away. Simultaneously, the owners all sign a Shareholder Agreement that contains language requiring the company to “buy-out” the surviving spouse for the death benefit amount of the insurance policy. In this way, when the insured owner dies, the money goes straight to the business which then passes this amount to the surviving spouse, effectively buying out that individual. This arrangement eliminates any legal responsibilities the former owner’s spouse had in the future of the business, while providing the surviving spouse with much needed income at their time of need. This arrangement also allows the other owners to freely make decisions without having to include this surviving spouse, who may not understand aspects of the company’s particular industry.
If all of your company’s owners are single, you may question whether key man insurance is relevant to your business. Is it worth the money? My answer is a resounding yes. Key man insurance can be used for a number of different functions that go well beyond buying out an owner’s spouse.
Think about the critical roles each of the owners play in the organization of your business. What would happen if one of these individuals had a fatal accident? Besides the natural grief that would grip your company as a result, who would be able to jump in and take on all of this person’s responsibilities? And what if there isn’t an individual available with the skills to step into such a role? How do you proceed with your business operations then?
Key man insurance can help your business overcome such a crushing blow. It provides the money necessary to get through this uncertainty until you find a competent replacement.
Determining the Amount
The amount of key man insurance that is necessary will usually be dictated by the insurance company. It will evaluate the health, medical history and functions of the proposed owner to be insured and it will calculate the reasonable value of said owner’s life. In this way, the insurance company prevents “over-insuring” the individual and the annual premiums for this key man insurance remain equally reasonable.
Once the insurance company advises you of the amount of key man insurance that your company can purchase, be sure to add the cost of the insurance premium into your annual budget. It may seem like an added expense, but having key man insurance is a practical way to cover your revenue needs and avoid management chaos in the event of a co- owner’s death.