The day-to-day demands of running a business can be all-consuming. Often, there’s little time left over to think strategically about the future—whether it’s mitigating potential risks down the road, ensuring the long-term viability and continuity of the enterprise, or putting plans in place to one day monetize your life’s work. This article takes a look at a few important considerations for the protection of you and your business.
Ensuring Continuity Through a Fully-Funded Buy-Sell Agreement
At some point, you or a partner are going to leave the business—whether due to a disability, retirement, or death. When that happens, how will the business be managed going forward? How will the value of the departing owner’s equity in the
business be determined; and who’ll have the right to purchase it? Perhaps most importantly, how will you or your family be paid (in a single lump sum or through a series of installment payments)?
Every business owner knows the importance of buy-sell agreements. Many of you have taken the time to sit down with your partner(s) and attorney to commit an agreement to paper. Few, however, have taken the necessary steps to put structures in place to adequately fund their buy-sell agreements.
To minimize the impact on the business (as well as the remaining owners), most buy-sell agreements are structured to provide an initial lump sum payment. The balance is then paid out in installments—either out of annual cash flows or assets. Often, partners will purchase life insurance policies on each other’s lives (either term or permanent life policies) with a guaranteed death benefit large enough to fund buying out the other’s interest in event of death. This can also be supplemented with disability insurance policies to protect against long-term disability.
A well thought-out exit strategy anchored by a fully-funded buy-sell agreement also provides your key employees and bankers with greater confidence in the long-term stability of the business. Ultimately, it’s about making sure you’re able to walk away (even if it’s not when you want or how you want)—that you or your family won’t be forced into a fire sale of your equity interest in order to quickly raise needed cash.
Even if you’ve already put funding in place, make sure you periodically revisit and review the coverage. Often, we see buy-sell agreements funded with term life because it’s generally quick and inexpensive. Like any other aspect of business planning, however, your coverage needs to reflect the changing state of the business. Buy-sell agreements that were funded 5-10 years ago (when the business may have been worth a fraction of what it’s worth today) simply aren’t going to provide enough funds.
Solving the Group Disability Income Replacement Gap
Have you ever really sat down and carefully considered how much of your actual monthly compensation your business’ group disability policy would actually replace? You’ve probably seen the number 60% mentioned from time to time. But group disability
is capped at a maximum amount, usually only covers salary (not variable compensation), and may be considered a taxable benefit.
Consider a typical group disability policy that’s capped at around $10,000/month (~$7,000 after taxes). If your total annual compensation averages $360,000, the policy won’t even cover 25% of your monthly gross income. There’s a strong likelihood you’d need to extensively tap into your savings, and stop contributions to retirement and college savings vehicles, if faced with a long-term disability.
By adding a supplemental individual disability policy that layers on top of your group benefit, a more reasonable income replacement percentage can be obtained to better protect you and your family from financial hardship.
But disability policies can be complex. Coverages—and even definitions of ‘disability’—can vary from policy to policy. Some key features you may want to explore include:
- Non-cancellable/guaranteed renewable
- Locked-in premiums
- An ‘own occupation’ definition of total disability (coverage that will continue when you can’t do the everyday duties of your job, based on education, training, and experience, even if potentially able to do other work)
- Residual/partial disability rider availability
- Optional rider to fund retirement plan contributions during disability period
- ‘Future increase’ option to increase coverage as income grows
Protection Plus Retention
Protecting your business doesn’t end with ownership continuity. Nearly every company has one or more critical rainmakers—the 20% who generate 80% of new business. The crucial employees who the business would be hardpressed to lose. What would
happen if they weren’t there tomorrow? How long would it take to identify, recruit, and train suitable replacements? And how much would your bottom line be impacted during that time?
Key person insurance is specifically designed to help protect the business by providing you with the financial means to weather the short-term disruption, regroup, and get back on track after the loss. Having key person insurance policies in place may also provide residual benefits such as:
- Helping facilitate access to credit, loans, and/or investment capital by reducing your overall business risk
- Making the business a more attractive M&A candidate
- Strengthening your relationship with those key employees by highlighting their importance
- Enhancing retention by offering a percentage of the death benefit to be paid out as part of the employee’s benefits package
- Providing the business with access to an additional source of cash (if the policy has cash value) in the form of withdrawals or loans
Augmenting Your Own Retirement
For business owners, a permanent life policy also offers a potential way to build additional tax-deferred savings, and serve as a valuable source of liquidity.
Even prior to retirement, overfunded life insurance can serve as a valuable source of liquidity. Rather than a line of credit or home equity loan, should the need arise, you can simply borrow from the accumulated cash value. And if a cash flow crunch occurs during a market correction, the policy’s cash value may prevent you from having to sell other investments at fire sale prices.1
A separate permanent policy (not connected to your buy-sell agreement) is often a great way to reach your retirement goal, while providing added protection along the way—just in case things don’t go according to plan.
While primarily a means to reduce risk, insurance has the ability to be a multi-faceted and multi-purpose tool for your business. We can help you explore the various types of coverage, and how each might align with your current and future business goals.
Working with Janney
Depending on your financial needs and personal preferences, you may opt to engage in a brokerage relationship, an advisory relationship or a combination of both. Each time you open an account, we will make recommendations on which type of relationship
is in your best interest based on the information you provide when you complete or update your client profile.
When you engage in an advisory relationship, you will pay an asset-based fee which encompasses, among other things, a defined investment strategy, ongoing monitoring, and performance reporting. Your Financial Advisor will serve in a fiduciary capacity for your advisory accounts.
For more information about Janney, please see Janney’s Relationship Summary (Form CRS) on www.janney.com/crs, which details all material facts about the scope and terms of our relationship with you and any potential conflicts of interest.
By establishing a relationship with us, we can build a tailored financial plan and make recommendations about solutions that are aligned with your best interest and unique needs, goals, and preferences.
Contact us today to discuss how we can put a plan in place designed to help you reach your financial goals.
1 Excess borrowing from a permanent life insurance policy may have negative consequences, including but not limited
to reducing the death benefit; causing the policy to lapse early, with potential tax consequences; or affecting policy performance.
Janney Montgomery Scott LLC, its affiliates, and its employees are not in the business of providing tax, regulatory, accounting, or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any taxpayer for the purpose of avoiding tax penalties. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.