Life insurance for business owners

A business owner usually has two separate life insurance problems and often solves only one. The first is personal: if you die, does your household still work? The second is the business: if you or another critical person dies, does the company survive the following six months, and does ownership end up where everyone intended? They need different policies, owned by different people, for different reasons.

Key person coverage

Key person insurance covers the loss of someone the business genuinely cannot easily replace — a founder, a lead salesperson, an engineer who holds the technical knowledge. The business applies for the policy, owns it, pays the premium and is the beneficiary. The money buys time: it covers the revenue gap, the cost of recruiting a replacement, and the reassurance that lenders and large customers will ask for.

Sizing it is a business exercise rather than a personal one. Look at the revenue or margin genuinely attributable to that person, the realistic cost and time of replacing them, and any debt or contract that would be called into question by their absence.

Buy-sell funding

If there is more than one owner, there should be a written agreement that says what happens to a deceased owner’s share. Life insurance is how that agreement gets funded, so the surviving owners can actually buy the share rather than finding themselves in business with an heir who did not sign up for it — and so the family receives money instead of an illiquid stake they cannot sell.

• Cross-purchase — each owner owns a policy on each other owner. Straightforward with two owners, unwieldy as the number grows.
• Entity purchase or stock redemption — the company owns a policy on each owner and buys the share itself.
• Hybrid arrangements that combine features of both, chosen for tax or control reasons.

Personal guarantees and business debt

Many owners have personally guaranteed a loan, a lease or a line of credit. That obligation does not disappear at death; it can follow the estate and reach the family. Owners are frequently surprised by this. The fix is usually straightforward: know the total exposure, and make sure there is coverage sized to it. Some lenders also require a collateral assignment on a policy, which directs part of the benefit to them and is worth understanding before signing.

Where this goes wrong

The most common problems are boring and repeated. An agreement written years ago with a valuation formula nobody has revisited. A policy bought for a buy-sell and then never matched to an updated agreement. Ownership and beneficiary lines on the policy that contradict the agreement. Coverage that stops at the business and leaves the owner’s own household with nothing. And a business that has grown considerably since the coverage was sized.

Tax treatment of business-owned life insurance depends on the structure, on who owns and who benefits from the policy, and on requirements that must be met before a policy is issued. The consequences of getting it wrong are real. Please work through it with your own tax adviser and attorney, alongside whoever places the coverage.