Owning a small business is often the dream of any employee working behind a desk or stacking boxes in a mega business. Millions of Americans run for this goal, often collaborating with someone they know and think it can help achieve this.
There are approximately four million commercial partnerships in the United States, judging from tax returns, ranging from the corner flower shop to factories and retail stores that employ up to 500 workers. The financial health of these companies is extremely important for customers, employees and the country as a whole.
Ironically, many small business partners don't think much about their health or what would happen if they died prematurely. Even among the strongest of the partnerships – family businesses – only about a third of the companies exceed the first generation, according to the 2019 US PwC family business survey. A probable scenario: there was no plan for what would have happened if one of the partners had been disabled or deceased. Only 18% of family businesses have a solid succession plan that has been documented and reported, according to the PwC survey.
There are two likely reasons for the lack of succession planning. The first is that when entrepreneurs start a business and hurry up the ladder of success, they put the idea that something could or could happen to them at the bottom of the to-do list. Take help, grow your business, create new products and compete at the center of the stage.
"In the beginning we just wanted to get into business and stay in business," says Maren Kravitz, owner of The Training Room, a personal training facility located on the outskirts of Boston. Although Kravitz is now the sole owner, she and her former partner drafted the original contract on the back of a paper towel. "You don't always plan for the future when you're not sure your business is successful," he says.
The second reason: even with success and advancing age, the problem of planning the death of a partner, or even yours, often makes the fire jump. Discussing a person's death, whether it's a family member or partner you see at work every day, is an uncomfortable topic to discuss.
But the alternative can be devastating. In business, potential partners often look for someone who integrates their skills. A partner could be the techno-geek or owner of the Internet, while the other could be the guru of marketing, business development and sales.
Regardless of how the success scenario unfolds, a small business generally has more than one "operator", the practical individual who makes the place work efficiently. Losing a "key person" can be "completely devastating," says Alex Reffett, co-founder of East Paces Group, an asset management company in Atlanta. "It may be almost impossible to replace them without serious consequences for the company."
An untimely demise of a business partner may just be the beginning of the nightmare. Some accountants describe it as a "death in the family without will", in which the family of the deceased – in need of money and fearing to be cut off from profits – ties the company to court.
Another looming problem could be the desire of those family members to now play a role in the business by making business decisions on which only the deceased partner was qualified to govern. This can ultimately lead to antagonism or, worse still, to the lack of skills needed to manage the business.
As a result, employees could decide to leave and customers could break ties. The company could potentially go bankrupt if a lump sum transfer of assets for a purchase to the deceased partner's assets is too large for the company's balance sheet. And to make matters worse, the IRS could move in and claim that additional fees are due if the transfer is handled poorly.
Take stock of the situation
So before something happens – or could happen – every small business should have an emergency plan. First, conduct an evaluation of the company and update it regularly. In this way, it answers all the questions about what the company earns, has in its coffers, sells or owns.
Next, evaluate the role of each partner (or partner) in the company in terms of experience, qualifications and even temperament. After all, someone must be the "face" of the company. What do they contribute and what would happen if they weren't there?
This also applies to those who do not play an active role in management, but continue to finance the business, especially if their shares need to be redeemed quickly. Anyone who is an integral part of the company must ask themselves the difficult question: "What do you want to happen to the company if you die?" As regrettable as it may be, having an answer is better than the alternative: "Your company may die with you."
I agree, so you don't have to disagree
One of the best ways to manage the potential death of a business partner is to have the classic purchase agreement. This type of agreement states that if a partner dies or becomes so disabled it cannot work, the other partner (or partner) has the legal right to purchase its stake in the company. This is usually written in a binding legal document and should be updated on a regular basis as the revenue and budget changes. The alternative is that the heirs may feel betrayed and reported.
If there are only two partners, they usually have a "cross purchase" purchase agreement. Each partner buys a life insurance policy from the other because they have an acquired interest in keeping their partner alive. If the other partner dies, they will have the money to keep the business going and buy the family of the deceased partner.
Another option is to use life insurance with a "share repayment plan", also known as an "entity purchase agreement". In this situation, the company buys a life insurance policy to cover the owners and then uses the life insurance proceeds to buy an owner's shares in the event of death. An advantage here is that the company does not have to liquidate assets to buy shares. In any case, life insurance provides immediate payment, removes the deceased's family from the company and gives them a nest egg to continue.
Summary: Life insurance for business partners
The life insurance strategy
Cross purchase purchase agreement
Each partner buys life insurance from the other. A payment is used to purchase a partner's family after death.
Repayment plan for stocks
The company buys life insurance on partners. A payment is used to purchase a partner's shares after death.
Use of "Key Man" life insurance
This, however, will not solve the problem of losing the talents and skills of a dying partner. Again, the right life insurance can come to the rescue. Many life insurers offer a so-called "key man" policy, which the company subscribes to with its partners or to any important employee such as the chief financial officer. Policy pays – often in millions of dollars – if one or one of the partners dies.
The proceeds of a "key man" life insurance policy can be used to purchase the spouse and heirs of the deceased partner. Most importantly, it can be used as a backstop to keep the activity active while the other partner (or partner) finds another rainmaker – an individual with talents similar to the one who died – and therefore pays his salary, bonuses and actions options, and perhaps even arrange for them to take the place of the partner.
A buy-sell life insurance policy is not necessarily the same as a key policy, although the same policy can serve both ends: the buyout and the stopgap. One difference: a "key man" policy is almost always owned by the company.
Term or whole life insurance?
One question that concerns anyone who buys life insurance is whether it is better to buy life insurance or full life insurance. Whole life insurance is usually much more expensive, but provides for a payment regardless of the insured's death. Useful life is cheaper but has a big question mark: will it pay? The duration does not include any payment if you do not die during the period of validity of the policy.
"Much depends on the specific age of the client, how long the policy must be implemented and whether it is needed outside the company, as for personal expenses," says financial advisor Louis Barberio of Penn Mutual.
With a buying and selling agreement between partners who are friends, a whole life insurance policy could offer everyone's family a little more financial security. On the contrary, a "young" company with limited resources can opt for a term life insurance policy, but also an older company, with older owners who don't expect to work forever.
Term life insurance policies are generally available for a period of up to 30 years or for the same period of time as the longest US Treasury loan. But if business partners mutually purchase life insurance policies, their beneficiaries will eventually receive a tax-free payment, even if the business is no longer operational.
A tax situation
Life insurance premiums paid for a purchase and sale policy are not tax deductible, although the death benefit is paid free of charge to the beneficiary.
"In some cases where an entrepreneur owns the life insurance policy – rather than the company – the company may be able to deduct the premiums as compensation for the owner," says president and CEO Brooks Tingle. by John Hancock Insurance.
As for Maren Kravitz, her personal training facility now has two locations and has grown to over 30,000 customers. "In hindsight, I am extremely understanding of how much business partners endure when they start their company for the first time," he says. "But I strongly recommend that all partners have these documents, specify what-if situations and keep them up to date."