What Happens When My Business Partner Dies?
It happens more often than you think and many business owners are not prepared. Does your business have a contingency plan if your business partner dies? Business owner life insurance can provide a contingency plan and keep your business from financial ruin should a business partner die suddenly.
Learning About Life Insurance The Hard Way
Craig and Jim were close friends from childhood. They went to the same college and even attended each others wedding. Ever since they were kids, they dreamed of starting a business together. When they graduated from college, they got together and formed a partnership doing what they both loved to do, customizing motorcycles.
The two men were skilled mechanics and could highly customize any bike to fit the needs of their clients. Soon word spread about their expertise and their unique craftsmanship was sought out by famous and wealthy clients. Their business was booming, they hired employees and formed a corporation, each with 50 percent interest of the business.
Then Craig died in a freak motorcycle accident. What happened next happens to many small businesses. Both families had most of their assets tied up in their business. When Craig suddenly died, his 50 percent interest did not go to his business partner Jim. Instead, his share of the business went to his wife, Donna.
Donna was working as a nurse and had a very demanding career. She had no time nor was she interested in running a motorcycle customization shop. But since she was now a 50 percent shareholder in the corporation, she was entitled to 50 percent of the income and profits of the business.
Jim was forced to hire a new manager to try to take the place of his partner. But no one was quite capable of filling his partner’s shoes. Jim worked longer hours, put more of his savings into the business, but sales started to dwindle without the creative minds of the 2 entrepreneurs.
Eventually, Jim and Craig’s wife were forced to sell the business. A competitor offered a ridiculously low price to take the problem off Jim’s hands. Jim sold the business and walked away with almost nothing.
This situation happens to business owners far too many times. Many business owners never take the time to make contingencies in the event of a partner’s death or even a disabling illness where an owner can no longer work in the business.
One of the most important ways business owners can ensure a long-term survival of a business is to implement a Buy-Sell Agreement. The buy-sell agreement is simply a contractual agreement for surviving partners or shareholders to buy out the interest of a deceased or disabled partner from his heirs at a pre-determined price.
The price can be a flat fee or an estimated value of the business agreed to in advance by all parties. A buy-sell agreement also guarantees the fair treatment of all the owners’ spouses or heirs. The estimated value can be revisited every so often as the business grows and the agreement is generally funded with a life insurance policy that pays off at a partner’s death.
Business Owner Life Insurance Provides Liquidity
Of course, outlining an agreement is one thing however, raising the cash to buy out the heirs is quite another. Many businesses do not always have the funds on hand to buy out the interest of a partner or shareholder who dies unexpectedly.
Term life insurance is the best solution for this purpose: For a very small premium, the company’s owners can purchase a term life policy on the others life and be assured there is enough liquidity for the business to take care of the deceased partner’s spouse or heirs.
With life insurance to fund the buy-out agreement, the surviving owners can operate their businesses free of unwanted meddling from the heirs because the heirs get the cash they need to live on and a fair settlement for their family member’s share of the business.
Cross Purchase Agreement
Another way to structure a buy-sell agreement when there are multiple partners or owners is to use a Cross Purchase Agreement. For example, each partner holds a life insurance policy on every other partner but in most cross purchase agreements, the corporation owns the life insurance policy and not the business partner. The corporation is also the beneficiary of the policy and the company then pays cash or buys out the surviving spouse or heirs.
Death isn’t the only problem that can cause the unexpected departure of a partner. If you have a partner who is actively involved in the business, and that individual becomes disabled and can’t work anymore, you have a similar problem – though life insurance wouldn’t pay out for a disability. In this case, you may want to explore having a special disability insurance policy on business owner-employees as well.
If you own a business or even a part of a business, you should have a Buy-Sell Agreement and fund it with life insurance. Every business needs a contingency plan or a business continuation plan if a business partner dies or becomes disabled.
Note: This should not be taken as legal or tax advice. These are just the views of a veteran insurance agent who has been in the business for more than 20 years.