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Planning for the future is just good business. You sign a long-term office lease, you borrow to buy a car or truck, and you ask your vendors to take payment next month for products delivered today. You honestly expect to make good on these obligations. Likewise, your spouse, family, business partners, bankers, employees, customers, and shareholders are all counting on you to honor all kinds of future obligations.
But what happens if a business owner runs out of future? When a business owner dies, the company can collapse into a giant mess, leaving loved ones struggling to hold up a house of cards.
If you’re thinking, “No problem, I’m insured,” think again. Life insurance is great, but the problem is not just the money. The real problem is one of control and transition. If you die, and your spouse (or other heirs) inherits your ownership, can they run the company? Do they even want to? Do your partners, employees, and customers want to work with them? Like it or not, your death would force together people who may be complete strangers with no particular interest or skill to make things better for each other.
After your (always untimely) death, your family and your business would both be better off if there is a way for them to each continue, separately. To make sure this happens, you need more than just a life insurance policy. You need a clear written agreement between all stakeholders: partners, key employees, stockholders, and, yes, your spouse or heir.
Every stakeholder should understand and sign what is called a buy-sell agreement. With that in place, the business continuity is more certain. Yes, your spouse still inherits your stock or ownership. But the buy-sell policy ensures that the remaining partners or owners use the proceeds from your life insurance policy to buy that ownership from your spouse.
Your family gets cash while your partners or employees get the company. It can be just that simple.
Now let’s look at life insurance again. A good buy-sell agreement relies on two separate life policies, both of which pay the company a substantial amount upon your death:
- A “key man” policy pays the company enough to get through your sudden departure and hire a qualified replacement. Consider this to be at least equal to one year’s salary. If your company has substantial debt, raise the death benefit to cover it.
- A “buy-sell” policy that pays the company enough to purchase your ownership back from your heirs should at least match the actual value of your business.
The key man policy keeps your business running. The buy-sell policy can get your family the money they need to be set for life, or at least get paid for all your hard work to date.
To get a proper buy-sell agreement (and insurance policies) in place, follow these four steps:
- First, speak with your accountant. Calculate how much the company would need to keep going (or, in the worst case, to wind down smoothly and pay all debts).
- Next, speak with your banker. If you have personally guaranteed any loans, or if your other corporate debt relies on your personal participation in the business, discuss how the business would pay this back upon your death. It is likely that these terms are already part and parcel of your loan documents; take a close look.
- Now look inside the company. Who would want to own and operate the company when you are gone? Is it a current stockholder or a key employee? Get those people involved in the discussion.
- When you have a workable plan, speak with an attorney to draw up the agreement. At this stage it’s important to have an insurance agent and all your key stakeholders involved. A buy-sell agreement should be signed by everyone involved, including your spouse and the spouse of any other key player, in some cases. Follow the attorney’s advice carefully; you won’t be able to renegotiate this when you are gone.
- Finally, once everyone who will survive you agrees on what happens next, make several copies of the document and keep them safe.
Remember: It’s your duty to make sure that your current business obligations don’t hamper those you leave behind. To protect your family and friends, don’t put off these important preparations.
David Worrell is founder and chief executive at AmeriStart, and he also writes a blog here on AllBusiness.com about small business money issues.