In a previous article, I wrote about safeguarding the future of your business with Key Person Insurance, a vital tool that business owners often employ for business planning and risk management.
Before we move on, let me give you a quick overview of Key Person Insurance.
Key person insurance helps to safeguard the future of a business in the event of the loss of one of its key people like the CEO, CFO, General Manager, or even a top-performing sales executive. These key people are tied to a company’s bottom line, and all directly impact a company’s ability to generate revenue. Losing a key person, then, comes with a heavy financial impact. Key person insurance helps to soften that blow with life insurance policies in the name of a company’s key people. More on this strategic use of life insurance here.
I’d now like to take you through another use of life insurance that business owners rely on for business planning and protection: ‘Partnership insurance’.
Partnership Insurance involves the purchasing of life insurance policies to protect the partners themselves, their families and the business and its employees, should one of the partners in a business fall unexpectedly ill or die.
How? A question that I’ll answer with another question.
Have you ever considered what would happen to the shares of your business if you or one of your business partners fall ill, become handicapped or die unexpectedly? The obvious answer here might be that the surviving partners would buy back the deceased partner’s shares.
A few more questions that stem from that: Where would the buy-back capital come from? Would you pay out of your pocket? Out of the business’ accounts? Could that have a financial impact on the business? What about the family of the deceased partner? What if they choose to be involved in the business rather than sell their inherited shares?
These are the grey areas that Partnership Insurance helps clear up, define solutions for and draw out an action plan for business partners at a time when decision-making is likely to be an ordeal.
How Partnership Insurance Works
Partnership Insurance provides business and its partners with the capital required to buy back the shares of the deceased partner. The proceeds of the insurance policy would ensure that the business can run with minimal disruption, the surviving partners are financially protected, and the deceased partner’s family receives fair compensation for their inherited business shares.
As a business partner, should you choose to protect your business with the help of Partnership Insurance, you have two ways of going about it.
One way is for the business to buy life insurance policies in the name of each of its business partners. The policies would typically be worth the value of the business shares that each partner owns. The business itself would be listed as the beneficiary and would receive the proceeds of the policies in the event of a claim.
This way the business would have sufficient funds for the surviving partner(s) to buy back the deceased partner’s shares, without this taking a toll on the company’s finances, and hence causing as little damage as possible to business operations.
The other way to purchase partnership insurance is for the partners to ‘cross-purchase’ policies in each others’ names. This approach works best with a two-person partnership. Each partner purchases a life insurance policy that insures the other partner. The policy buyer is the beneficiary, and in the event of sudden illness or death of the other partner, he or she would receive sufficient funds to purchase their partner’s shares at a fair value.
Once again, this safeguards the partners’ finances, gives the deceased partner’s family the best chance at receiving a fair value for their shares, and protects the business by causing minimal financial disruption.
Double Option Agreement
It is important to note here, however, that purchasing partnership insurance using either of these approaches does not make it mandatory for the sale of shares to take place.
The family of the deceased partner could choose to remain a part of the business by virtue of having inherited the shares. This is not always a favorable situation. The family members of a business partner might not be sufficiently experienced or able to replace the deceased partner and shoulder their responsibilities in the business.
In order to ensure that a deceased partners’ shares are bought out by the business or by the surviving partner(s), a supporting document called the ‘Double Option Agreement’ is drawn up to enforce the transfer of the deceased partners’ shares at the pre-defined value of the shares.
What Happens Without Partnership Insurance?
Over the course of my career, I have worked with many business owners who run many different types and sizes of business operations. I have seen how Partnership Insurance has helped business owners make it through what can be a particularly challenging time, with almost no dent in the company’s or their personal finances.
On the other hand, I have also seen a few different scenarios where business partners have faced several problems without having this key protection tool in place.
Some of these scenarios are:
- A growing business can come to a grinding halt. The buy-back of shares might mean that the business falls short of cash for the planned growth and expansion that was mapped out before a partner unexpectedly died.
- A surviving business partner can take a major financial hit if they are forced to buy back shares with their personal finances.
- The lack of sufficient funds might lead to the forced and/or unwanted involvement of the deceased partner’s heirs. This can create an unpleasant work environment and ruin relationships.
- The business could potentially buy back the deceased partner’s shares but face a financial crisis in the months to follow. In addition to the immediate financial loss, the business might potentially also have lost a key revenue-generator when it lost a partner. Recovery from this can take a long time, or in some cases, never really happen.
- Old friendships and family ties get torn down due to disagreements on the value of the shares and what makes a fair compensation to the deceased partner’s heirs. This leads to an ugly negotiation that could end in a long-drawn legal battle, further draining all the parties involved.
All in all, Partnership Insurance can help business owners at a time when they need it most. The emotional distress of losing your business partner, the added workload that becomes your burden to carry until you are able to replace your partner, and a whole new work dynamic to adjust to, all make this a stressful, difficult time for a surviving business partner.
Partnership Insurance kicks in and takes care of the big practical aspect that has to be dealt with when the unexpected happens. It ensures the fair and proper division of shares, in a way that causes minimal damage and disruption to the partners, their families and the business itself – all the things worth protecting.