Business Continuation Planning
The departure, death, or disablement of a key executive or employee can cause stress and financial difficulties. In some cases, the lack of clear leadership can create disruption so severe the business may have significant declines in sales or may even fail. To address this concern, businesses benefit from a business continuation plan.
Buy-Sell Agreements and Key Person Insurance are two essential types of business continuation plans that leverage insurance to protect the ongoing operations. These plans are designed to cover losses that may occur if a key executive, business owner, or partner were to pass away or become disabled or someone that is instrumental to the success of the business has moved on or retired. By providing funds to the business through these two mechanisms, these policies can help minimize disruptions and ensure that operations continue smoothly. Additionally, they can assist businesses in implementing a succession strategy that aligns with their specific needs and goals in the event of losing a key employee.
The following provides further explanation regarding these two types of business continuation plans.
Buy-Sell Agreement
To minimize financial disruption and protect business owners against occurrences due to the departure, disability, or death of an owner, Ocean Bay Tax Strategies provides business owners and stakeholders with a strategy for funding succession.
There are two types of buy/sell agreement plans: cross purchase plan and entity purchase plan.
Cross Purchase Plan: In a cross-purchase plan, each business owner purchases a life insurance policy on each of the other owners. When an owner dies, the remaining owners use the payout from the life insurance policy to buy the deceased owner’s share of the business.
Entity Purchase Plan: In an entity purchase plan, the business buys life insurance policies on the lives of each owner and pays the premiums. When an employee-owner dies, that share of the company passes to the heirs of his or her estate, and the business can use the policy’s death benefit to buy the interest from the estate.
A buy/sell agreement provides many potential benefits for the business owners, including:
- Creating a fair market value exchange,
- Promoting an equitable and orderly transfer of wealth, ownership, and management,
- Offering tax advantages,
- Guaranteeing heirs a buyer for assets they may not know how to manage, and
- Providing heirs cash to pay estate debt, expenses, and taxes.
For employees, a buy/sell agreement provides a way to purchase a business they have a vested interest in but may not have the capital for. It also assures remaining owners that the deceased’s share of the business will not pass on to someone unsuitable and assures continuity for customers, creditors, and employees.
Key Person Insurance
Key person insurance is a type of life insurance policy that businesses can take out on their most valuable employees. These employees are considered indispensable, and their loss would have a significant impact on the business. Key persons are often business owners, but they can also be individuals with highly specialized roles or those responsible for generating a significant share of the company’s revenue.
The policy is owned by the business, which also pays the premiums and is the beneficiary. In the event of the key person’s death, the business receives a death benefit that can be used to replace lost revenue while they search for a replacement. Disability coverage can also be added as a rider to the policy.
Some lenders may require businesses to purchase key person insurance to receive financing.
Overall, key person insurance can provide a financial lifeline for businesses in the event of the loss of a key employee.