Life insurance for business owners

The three jobs

• Family protection — replacing income and covering household obligations
• Ownership transition — funding a buy-sell agreement so the business changes hands cleanly
• Business continuity — key person coverage, and repaying debt the business or you personally guaranteed

Buy-sell agreements need funding

An agreement saying the surviving owners will buy a deceased owner's share is a promise, not money. Without funding, the survivors have to find the cash from a business that has just lost an owner — or the family ends up as an unwilling partner.

Life insurance is the standard funding mechanism, and the structure matters.

Structure choices

Each of these has different tax, basis and administrative consequences, and the right one depends on the entity type, the number of owners and their ages. This is genuinely accountant-and-attorney territory.

• Cross-purchase — each owner owns a policy on each other owner
• Entity purchase — the business owns policies on the owners
• Trusteed cross-purchase — a trustee holds policies, simplifying multi-owner arrangements
• Hybrid — the agreement chooses at the time of the event

Key person coverage

This is coverage the business owns on someone it depends on, paying the business rather than a family. It buys time — to recruit, to reassure lenders and customers, to absorb lost revenue.

Insurable interest is required, and the person insured generally must consent in writing. Get that documented properly.

The personal guarantee nobody counts

Owners routinely guarantee obligations personally and then leave the amount out of their coverage calculation. Check what you've signed.

• Bank loans and SBA loans
• Lines of credit and equipment financing
• Premises leases
• Supplier and trade credit accounts
• Any obligation where you signed as an individual as well as for the company

Review the amounts annually

Business valuations move; policies don't. The most common defect in these arrangements is coverage set at a valuation from years ago, funding a buyout at a fraction of current value.

Put valuation and coverage on the same annual calendar as the accounts.

Who should own the policy

Ownership decides where the money lands and what it can be used for, and getting it wrong is considerably harder to unwind than to set correctly at the outset.

For key person cover the business generally owns the policy, pays the premiums and receives the benefit, because the loss being insured is the company's. For personal cover protecting your household, you generally own it personally so the proceeds reach your family directly rather than through the business.

For buy-sell funding the answer depends on the structure, and it is the decision most worth taking advice on. Mixing these up - a business owning a policy meant for a family, or an individual owning one meant to fund a buyout - produces tax and access problems that only surface when the policy is needed.

Cross-purchase and entity purchase

Buy-sell agreements are funded one of two ways, and the choice has practical consequences beyond the paperwork.

In a cross-purchase arrangement each owner holds a policy on each of the others. It is clean with two owners and becomes unwieldy quickly - four owners means twelve policies, and each owner is paying premiums on lives at different ages and health.

In an entity purchase the business owns one policy on each owner and buys back the departing interest. Fewer policies, simpler administration, and a different tax treatment. Neither is right in general; the arithmetic of how many owners there are usually decides it.

The valuation nobody schedules

A buy-sell agreement funded to a valuation set years ago is funded to the wrong number, and this is the most common failure in the whole area.

Agree how the business will be valued and how often the figure is revisited, and put the review in the calendar rather than intending to get to it. A growing business outgrows its funding steadily and invisibly.

Underfunding is the usual outcome: the agreement obliges a purchase at a price the insurance no longer covers, and the shortfall falls on the surviving owners at exactly the moment the business is least able to absorb it.

The personal guarantee nobody counts

Business owners routinely guarantee company borrowing personally, and routinely leave it out of their personal life insurance calculation.

A personal guarantee generally survives you and lands on your estate, which means it lands on your family. It belongs on the list of debts when sizing personal cover, alongside the mortgage.

Check what you have actually signed rather than what you remember signing. Guarantees attach to lines of credit, equipment finance and commercial leases as well as to loans, and they are easy to accumulate without noticing.

What to review each year

• The business valuation, and whether the buy-sell funding still matches it
• Whether the ownership structure still matches who the policies are meant to protect
• Whether any new owner has joined and been brought into the arrangement
• Whether any personal guarantees have been added since the last review
• Whether key person amounts still reflect what that person's loss would cost
• Whether the beneficiary designations still name the right parties

Key person cover, sized honestly

Key person insurance is life cover the business owns on someone whose loss would materially damage it. The business pays and the business receives the benefit, and the point is buying time rather than replacing a person.

Sizing it means asking what the loss would actually cost: revenue at risk while relationships are rebuilt, the cost of recruiting and onboarding a replacement, any lending that would become repayable, and the period the business would need to stabilise.

It also requires the individual's consent, which is a legal requirement rather than a courtesy. Insuring someone's life without their knowledge is not permissible.

What happens without funding

An unfunded buy-sell agreement is a promise, and the failure mode is worth stating plainly because it is what the funding exists to prevent.

On an owner's death the agreement obliges the surviving owners or the business to buy the departing interest. Without insurance the money has to come from cash the business needs, from borrowing at the worst possible moment, or from instalments the deceased's family may not be able to wait for.

The alternative outcomes are worse still: the family inherits a share in a business they cannot run and cannot sell, or the surviving owners end up in partnership with someone they never chose.

Tax treatment, briefly and with a caveat

The tax position varies with the structure, the entity type and the jurisdiction, and this is one of the areas where general guidance is least reliable.

Broadly: premiums on a policy the business owns for its own benefit are generally not deductible, and the benefit is generally received free of income tax, though there are conditions and exceptions - particularly around employer-owned policies, where specific notice and consent requirements apply and failing them can change the treatment.

The practical instruction is simple. Any arrangement where a business owns cover on an individual, or where policies fund a buy-sell agreement, is worth running past an accountant before it is put in place rather than after.

When ownership changes

Businesses take on partners, buy each other out, incorporate and restructure, and the insurance arrangements rarely follow.

A buy-sell funded for three owners does not automatically accommodate a fourth. A cross-purchase arrangement becomes considerably more complex with each addition. And a policy owned by an entity that no longer exists in the same form is a problem discovered at the worst moment.

Any change to who owns the business should trigger a review of who owns the policies, who is named, and whether the amounts still match. It belongs on the same checklist as updating the operating agreement.

The short version

Separate the three jobs - protecting your household, funding a buyout, and covering the loss of a key person - because they need different amounts and often different owners. Fund the buy-sell agreement, agree how the business is valued, and put the revaluation in the calendar. And count your personal guarantees when sizing personal cover, because they survive you.

Consent is not optional

Insuring another person's life requires their knowledge and written consent, and for employer-owned policies there are specific notice and consent requirements that have to be met before the policy is issued.

Failing them is not a technicality. It can change the tax treatment of the benefit and, in some circumstances, affect whether the policy pays at all.

For a co-owner or key employee, that means a conversation rather than a form pushed across a desk - which is generally the right thing to do anyway.

Put the review in the calendar

Business valuations, ownership structures and personal guarantees all change quietly, and none of them prompt a review of the insurance. Schedule one annually alongside whatever else the business reviews.

Take advice on the structure

The ownership and tax questions here are genuinely specialist and the cost of getting them wrong is high. Any arrangement where a business owns cover on an individual, or where policies fund a buy-sell agreement, is worth running past an accountant before it is put in place rather than after.