Many people start thinking about life insurance when they start a family. What if your business is your “baby”?
Whether or not you’ve got actual kids, when you’re an entrepreneur, you have a legacy to protect and other people’s financial needs to consider.
Here’s why life insurance is often a necessity for entrepreneurs, and priorities they should keep in mind—for their businesses and their families.
The most important reason to get life insurance is to protect the people who mean the most to you. Your family supports you as you grow your business, and they rely on you in return.
If you opened your doors with business partners, a life insurance payout can also help keep them from losing their dream without you. While there’s no replacing a person, a life insurance benefit can cover the critical financial support you would’ve otherwise provided. That means essential financial goals for your family and business can still be in reach, even if you pass away.
For entrepreneurs, life insurance can also be a step toward important business opportunities. Besides protecting loved ones, there are a few business-specific reasons to consider a life insurance policy.
You’ve probably heard the saying, “You have to spend money to make money.” Starting a business or scaling up your growth often involves investing in property or equipment.
Many entrepreneurs turn to a small business loan to get the funds they need. If that’s you, you might find a life insurance policy on the list of requirements for loan approval. Loans backed by the U.S. Small Business Administration (SBA) require life insurance for entrepreneurs in most cases.
Even if you’re not going after an SBA loan, commercial lenders may require life insurance in their internal policies. This is especially likely if the business would go down without you.
A term life insurance policy generally meets this requirement. You’d take out a policy term that matches or exceeds the life of the loan. That would assure the lender that if you die, there would still be a way for your estate to pay back what you owed.
Some entrepreneurs also use life insurance as collateral for a loan. You don’t name the lender as the beneficiary of your life insurance policy, but you can set up a collateral assignment. That’s an agreement to pay the lender the balance of the loan first, then direct the rest of the insurance payout to your beneficiaries.
This latter approach only works with assignable, permanent life insurance policies that have a cash value large enough to cover the collateral requirement. (What’s the difference between term and permanent life insurance?)
Some entrepreneurs hope their company will continue after they’re gone. Life insurance can make funds available to keep the business afloat during an unexpected transition.
That’s why some business partnership agreements or succession plans include a life insurance component. Your business partners and legal advisor may suggest that all owners have a life insurance policy large enough to fund the time it’d take to find someone to replace the co-owner’s role.
When you die, your estate will inherit your share of the business. You might prefer to set co-owners up to “buy out” your share from your family using life insurance proceeds. That would let your business partners continue the company in your absence, while leaving your family with additional cash as an inheritance.
If you run your business solo, a life insurance plan can still help fund operations as your designated successor takes over the company.
Small businesses can range from a one-person side hustle to a multi-million-dollar operation. There isn’t one perfect “entrepreneur” policy, because there isn’t such a thing as a “standard” entrepreneur.
If you’re working on a lean budget, you’ll probably want to look for solid protection at a minimal cost. Entrepreneurs need to protect both their personal and business obligations. Term life insurance will generally be your best choice for affordable coverage.
If you’re well-established and have the funds to pay higher premiums, looking into a permanent policy with cash value might be worthwhile. Besides budget, your investment preferences (such as how much risk you like to take) will guide whether using insurance as a form of investment is right for you.
The good news is, you don’t need to lock yourself into one option. Byron Deese, a retirement plan consultant at Glass Jacobson Financial Group, says some entrepreneurs might find their best fit by buying a term life insurance policy that can convert into a permanent type later.
For other business owners, it might be easiest to purchase multiple policies. You might get a term life plan that covers your family, for example. Then you might get a separate policy that covers your business debts and transition costs for a co-owner. This avoids needing to set up multiple beneficiaries or leaving complex instructions on a single policy.
As an entrepreneur, you probably have a longer list of financial obligations than most. After all, you’ve got personal obligations and you run a workplace. You might have a co-owner and employees who rely on the paycheck you provide.
A life insurance policy can financially stabilize a transition period for the business.
“From the perspective of the other partners . . . equivalent to what the person was producing or what they expected to receive,” Deese says. “Prepare to fund the time it takes to replace that person.”
A co-owner or high-level employee generates a certain amount of revenue for the business and provides value in terms of their creative, strategic or management skills. The hiring process for a new executive can take months to nearly a year. Not to mention that your replacement needs time to come up to speed.
Deese recommends covering several years’ worth of your contribution to the company, to cushion a transition period.
Covering business liabilities and debts factors in, too. Outstanding costs related to your business might include:
Lease or mortgage on business property
Payment due to employees or contractors
Income or sales tax obligations
These debts need to be paid, even if the business closes when you die. If there isn’t enough in your business accounts to cover the balance, your family may have to pay out of your personal assets, depending on your business structure.
If you’ve structured your business to remain separate from your personal assets, creditors can only go after business assets.
Still, this can be a huge strain on a business partner. For entrepreneurs running single-member LLCs, state law determines whether the business will dissolve automatically or pass to an heir. If the latter, your heir would have to figure out what to do with it.
If you don’t have a co-owner and plan to end the business when you die, it might be sufficient to get a life insurance policy that covers your debts. You can name your company’s legal entity (such as your LLC) as the beneficiary to keep the funds within the business’ assets.
If you’re naming an individual as your beneficiary, it’s worth making sure that person is aware of your business debts and any loose ends. That’s because he or she will probably be ultimately responsible for them.
Leave a list of these obligations somewhere your beneficiary can find it again easily, so they know what bills you intended to cover out of the life insurance benefit.
A legal or business advisor can help you check any special requirements if you’re getting life insurance as part of a business agreement, like a buy-sell agreement.
Entrepreneurs should consult a professional for advice on the best insurance policies and succession plans for their needs.
Depending on your situation, life insurance may not only protect your family; it can also help open doors for business opportunities like loans. The right level of coverage provides valuable security for your business and family’s future alike.
Fabric exists to help young families master their money. Our articles abide by strict editorial standards.
This article is meant to provide general information and not to provide any specific legal advice or to serve as the basis for any decisions.
Fabric isn’t a law firm and we aren’t licensed to practice law or to provide any legal advice. If you do need legal advice for your specific situation, you should consult with a licensed attorney and/or tax professional.
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Fabric Instant is an Accidental Death Insurance Policy (Form VL-ADH1 with state variations where applicable) and Fabric Premium is a Term Life Insurance Policy (Form ICC16-VLT and CMP 0501 with state variations where applicable). Policies are issued by Vantis Life Insurance Company. (Vantis Life), Windsor, CT (all states except NY), and by Vantis Life Insurance Company of New York, Brewster, NY (NY only). Coverage may not be available in all states. Issuance of coverage for Fabric Premium is subject to underwriting review and approval. Please see a copy of the policy for the full terms, conditions and exclusions. Policy obligations are the sole responsibility of Vantis Life.