What are the benefits of key man insurance if I’m in a business partnership?
There are some employees that are crucial to the ongoing success of a business. For a company run as a partnership, both partners play important roles in keeping the business afloat.
If one of those partners suffers a serious illness or passes away, this can have a huge impact on the profitability of the company. Other problems can also arise, such as the lost partner’s ownership stake going to his or her beneficiary instead of someone who’s actively involved with the business.
Key man insurance is designed to offer critical financial protection against:
- The loss of revenue associated with the absence of a key partner
- Cost of finding and training a replacement
- Price of transferring ownership
Can key man insurance protect business partnerships?
Key man insurance helps solve several difficult financial situations that can emerge following the loss of a critical individual. Taking out a policy means deciding who your business simply couldn’t do without and getting them insured.
In some cases, two executives might personally take out key man policies on each other, or the entire board of a company might insure each other in the business’ name. The proceeds of the policy can then be paid directly to the business or to an individual.
How business partnerships take advantage of key man insurance
- Succession planning. The shares held by the key person are usually transferred to their family or other beneficiaries if they pass away. Key man insurance can provide the funds needed to buy them back and smoothly transfer ownership. If there are buy/sell agreements in place where stakeholders have entered into a contract on what to do with their shares upon death, then the key man insurance payout can facilitate these plans.
- Business debts. What if the key man puts his or her name on business loans before passing awa, or personally guaranteed loans made to the company? Key man insurance can be used to pay off the debts of a business partner in order to maintain the company’s reputation and credit rating.
Surviving a key loss
Richard and Bradley’s financial services company had been in operation for just over a year. Rich handled most of the numbers and behind-the-scenes work, while Brad maintained client relationships and focused on sales. With the help of their insurance broker they found a good key man policy and each took one out on the other, nominating the company as the beneficiary.
In a tragic misfortune, Brad was involved in a fatal car crash, colliding with both another car and a billboard. He died instantly, and Brad’s wife inherited his half of the company. It was now Rich’s job to reacquire company ownership.
Using the lump sum paid from key man insurance he made Brad’s wife a solid offer, which she accepted. Having required full ownership, Rich paid off debts and used the rest of the funds to recruit and train a replacement.
What happens if there’s no key man insurance?
Without key man insurance there would have been some implications:
- Brad’s wife would have had the stock in the company. Stock that she might have wanted to sell.
- Rich may want to buy stock back. However, Rich may not have had the cash to pay for Brad’s portion of the company.
- Lose-lose situation. Without the adequate funds to buy out Brad’s wife’s ownership, Richard may have low-balled her. Alternatively, Brad’s wife could have sold to another buyer and offset the course of the company.
When will key man insurance pay out?
In the context of business partnerships, key man insurance can pay out if a business partner:
- Passes away
- Develops a serious medical condition
- Is disabled due to an injury or illness
What losses can key man insurance cover?
The purpose of key man insurance is to cover:
- Lost revenue. If a talented salesperson passes away or a big project has to be cancelled, the lost revenue can be offset.
- Recruiting. Pays for training a replacement to handle the essential tasks the key person was responsible for.
- Funding future growth. The sum paid can be used to find new opportunities, secure loans and provide for business expansion.
- Retaining clients. If a key person has cultivated successful relationships, then key man insurance can help pay for gifts or services to maintain a connection with your customers.
- Outstanding debts. The insurance payout can settle any business loans or debts held by the key man to maintain your business’ credit rating.
- Ownership transitions. The insurance payout can fund the acquisition of shares from the deceased’s beneficiaries and otherwise pay for the costs of transferring ownership.
Is key man insurance tax deductible?
No, the insurance premiums are not tax deductible. The only situation in which premiums would be deductible is if the business does not benefit from the insurance policy — meaning the death benefit is paid to the key person’s family, and not to the business.
Are there alternatives to key man insurance?
There is no direct alternative to key man insurance, but there are other options which might be preferable for your business in the event of the loss of a key person:
- Take out a loan. This is another way to access funds at a crucial time and because it’s done after the loss of your key person, you can accurately judge how much you’ll need. However, lenders may be hesitant to offer money to a company that’s just lost a key person — or they may offer poor rates.
- Cover the loss with company profits. If you’ve accumulated a reserve for emergencies, you can recover from the situation with the current year profits. Naturally this is only an option if your business is sufficiently profitable, but it might not be best for the bottom line.
- Sell off assets. This can help you raise money fast, but you generally won’t get your money’s worth. Businesses generally don’t hold unnecessary assets, so you’ll likely be selling off useful equipment.
Often referred to as…
You might’ve also seen key man insurance referred to as
- Key person insurance
- Keyman insurance
- Key employee insurance
Key man insurance is fairly cost-effective when compared to alternative options. On top of that, having a policy in place could keep your company flourishing in a difficult time. Talk to your business partner(s) to see if a key man policy is the right decision. If it is, start comparing policies and purchase the coverage that’s flexible and makes sense for all parties involved.