Key Man for a small business

[LGilmore]

"It seems to me the unfairness is the difference in the cost of the policies"

Is this really a problem? I don't think so because mainly when you get to this point the value of a buy sell agreement is pretty clear. If A pays a little more premium or even alot more premium than B, does it really matter? That's a molehill guys. The mountain is what happens without a buy sell? We're not buying policies for the premium, we are buying for the potential payout and settlement of the business with ease.

 

[djs]

A key man policy is put in place by the business to cover anyone they deem critical to the ongoing operations of the business. It is not limited to partners, it could be a strong sales manager, or virtually anyone that place a key role. These are paid for by the business and benefit the business, not the families. In fact, the families don't have much to do with these policies.

In a buy/sell, the business should never pay for the coverage. This defeats the purpose of the funding for the buy/sell. Any premium differences are a reflection of the risk / likelihood of collecting on the premium paid. Since in a buy/sell, the buyer can use any funding option he chooses, it is simply a convenience to fund via life insurance, not a requirement. If the premiums are unreasonable, use your own cash to fund the agreement. Remember, the life policy is only a tool to fund a separate agreement, not the agreement itself.

Dan

 

[James]

First off, if shares or stocks are involved, funding a Buy/Sell with insurance could very well be illegal. As the Shares/Stocks would be consider a Liability under FAS 150, even though some are fighting it tooth and nail, haven't kept up with it recently, has a final ruling come down?

Buy/Sell, basically you have two policies, one pays for the other. So either has assets of their business plus the insurance they are paying for. Their Family though will only realize assets of the Insurance Policy not the Business, why would anyone do that? Listen, all I have to say is this to the business partners or owners, why not simply buy your own policy and fund the business you all built via the business, if it is a succesful business? (I consider it good odds that one of the partners will get it.) This way each of your families will recieve 100% of your assets you created. To back me up, I simply suggest they have this funding reviewed by their CPA or Attorney, if they do, case close. The old agent is out and I'm in.

Oh, yea I just breath to hear the words, "Well, you know Joe just couldn't do that, fund it on his own".

Now comes this, A key man policy is put in place by the business to cover anyone they deem critical to the ongoing operations of the business. It is not limited to partners, it could be a strong sales manager, or virtually anyone that place a key role. These are paid for by the business and benefit the business, not the families. In fact, the families don't have much to do with these policies. Oh yea, another great idea! So you go to your key employee or employees and tell them, we are going to take out a life insurance policy on you, okay. What words would you expect to hear from this rather smart "key employee"? I wouldn't agree to it unless something is in it for me! Of course, I know the come back which isn't so bad, and why it takes cash value of one sort or another the skirts the discrimination laws of employment. And by the way, whatever you do, don't call it a COLI or a BOLI!

Ps, that is if you inform the employee of this arrangement, obviously somehow (I can only imagine how they did this) some businesses got away without telling (or properly informing their employees) and took policies on everyone expecting a hell of a windfall in some years! You'll are killing me!

Ps Ps, in some cases a Buy/Sell funded via life insurance is suitable, in most it is not a suitable arrangement, of course IMHO.

 

[djs]

You really don't understand this do you? You couldn't cancel the existing policy on the business owner, since it is owned by someone else.

If the family wants the business, they wouldn't have entered the buy/sell agreement in the first place. Most families would rather have the $$$ than the business. Of course, they could buy a large policy and simply close the business, which I think is what you are saying.

Also, given the amount most keyman policies are for, you can't get it without the persons knowledge. Physicals are involved, medical records are involved, etc. People in this position are usually well compensated and it is part of their contract. You don't have a keyman policy on the janitor, or the person in manufacturing that puts the covers on. This is not a BOLI or a STOLI, clearly.

Can you please explain this statement:

Listen, all I have to say is this to the business partners or owners, why not simply buy your own policy and fund the business you all built via the business, if it is a succesful business?

How can you fund your business with your own life policy if you are alive? Or do you mean the family would end up with the life proceeds and the business? If so, you are correct. Now, this is good if they want the business. If not, why not have someone buy it from them while it is still a viable business? If this is good, do you care if someone does this with life insurance or his own cash? Of course not. This is niether a BOLI or a STOLI either. I'm not sure why you keep bringing this up.

Let's check definitions:
BOLI - Bank owned life insurance. Not in this case, no bank involved.
STOLI - Stranger owned life insurance (i.e. investor) In both keyman and buy/sell, it is done with a known entity with an agreement in place, for a specific purpose. Not a STOLI.

Do you have different meanings?

Dan

 

[James]

Got another one, who exactly pays the taxes? I mean good ole' Bob dies and his business was brought via insurance thru a Buy/Sell. Now who pays taxes on his business estate side, if taxes are due?

IRS Agent calling Mrs Bob: "Oh Mrs Bob, your husband assets equal XXX, now we have a bill for you."

Mrs Bob, "Oh, Mr Joe brought that via Life Insurance, go talk to him"

IRS Agent, "No Mrs Bob, I rather talk to you, I'll talk to Mr Joe tomorrow but today is all about you Mrs Bob."

Just curious? Basically I can see where the IRS Agent would be bewildered on this exchange if this issue is not clear to Mrs Bob.

 

[djs]

If it was bought with cash, who would pay the taxes? Same answer. Life insurance has nothing to do with this.

 

[James]

You really don't understand this do you? You couldn't cancel the existing policy on the business owner, since it is owned by someone else. This can be done with a swipe of a pen, owner A cancels B and B cancels A or they simply switch owners depending upon what type of policy it is. If one partner pulls out it makes no sense for the second to stay. If owner B decides to keep the policy even though A pulls out, that is a serious weakness of the plan from the get go. You do understand that partnerships can eventually split for various of reasons and sometimes it isn't a pretty sight, yet one will hold a life policy on the other. Thank you for bringing up another weakness of the insurance funded Buy/Sell agreement. My next obvious stop was the tax issue but this is good also!

If the family wants the business, they wouldn't have entered the buy/sell agreement in the first place. Most families would rather have the $$$ than the business. Of course, they could buy a large policy and simply close the business, which I think is what you are saying. Most families would rather have both (business and the policy) if their spouse died, IMHO.

Also, given the amount most keyman policies are for, you can't get it without the persons knowledge. Physicals are involved, medical records are involved, etc. People in this position are usually well compensated and it is part of their contract. You don't have a keyman policy on the janitor, or the person in manufacturing that puts the covers on. This is not a BOLI or a STOLI, clearly. BOLI, can be either Bank owned or Business owned, okay let us call it COLI, that is what it is and it is basically what a Buy/Sell and surely what a Key Man Policy is. The business pays for the policy directly or indirectly in a Buy/Sell, but the business always buys a Key Man Policy.

Can you please explain this statement:

Listen, all I have to say is this to the business partners or owners, why not simply buy your own policy and fund the business you all built via the business, if it is a succesful business?

How can you fund your business with your own life policy if you are alive?
This was in reference if one died, the other would finance the purchase of the business via the business, after the death of the partner or whomever. This may take a very simple paragraph within each other wills to provide certain instructions on how the loan for the business purchase should be handle by his family. A sucessful business should have no problem paying for itself in time. This way the family recieves the insurance plus a steady stream of cash as in a form of a loan by the surviving owner for the value of the business. Which is not all that uncommon!

Or do you mean the family would end up with the life proceeds and the business? If so, you are correct. Now, this is good if they want the business. If not, why not have someone buy it from them while it is still a viable business? If this is good, do you care if someone does this with life insurance or his own cash? Of course not. This is niether a BOLI or a STOLI either. I'm not sure why you keep bringing this up. That is why one is better to concentrate on a Continuation Plan. It creates a better return for the owners family but, hey if the family does not want the maximum amount of their beloved spouses estate more power to them! I rarely find that to be the case, now that is my expierence, YMMV. Plus you have to remember, these policies can sit for years, and things do change!

Let's check definitions:
BOLI - Bank ( or Business or we can just call it COLI which is exactly what we are talking about) owned life insurance. Not in this case, no bank involved.
STOLI - Stranger owned life insurance (i.e. investor) In both keyman and buy/sell, it is done with a known entity with an agreement in place, for a specific purpose. Not a STOLI.

Do you have different meanings? I guess so!

Dan

Oh man, how people can have varying views on such simple ideas!

 

[James]

If it was bought with cash, who would pay the taxes? Same answer. Life insurance has nothing to do with this.

Yes this is true, but in my scenario the surviving spouse would have the life policy plus wouldn't owe no taxes because she/he is a spouse and simply takes the business, at least with my limited knowledge of tax issues I think that to be correct. In your case an actual tax transaction will occur or possibly occur as in the business being sold, of course I'm once again not a tax expert. If you can enlighten me on this, great!

Now I understand there is no clear cut answer to this discussion we are having. Yet I'm confident that in my way of doing things the spouse of the owner is better protected then in yours. Of course if there is a spouse, I just assuming there is.

 

[bobson]

Here is the key point: Most surviving partners don't want to go into business with a surviving spouse that doesn't work in the business. It really is that simple. If partner A and partner B spent twenty years building a business without the hands-on-help of either spouse, do you suppose partner B wants to listen to partner A's widow when it comes to future business decisions? Not a chance. Hence the partners use discounted dollars via life insurance as a way to make sure widow A receives enough money to compenstate her for the family's loss of the income from the business.

(It really is no different than Joe Sixpack buying life insurance to replace his paycheck if he dies too soon. The business owner situation is more complex but fudnamentally it is the same idea.)


I've seen situations where widow A gets half a business and believe me none of them have turned out well. Widow A expects income without working in most cases. And even if she wanted to work, do you suppose partner B has enough time in his day to do the job of partner A, the job of partner B, and teach widow A the business? No way.

Instead of buying the business with discounted dollars prior to the death of partner A (via life insurance), the business pays for it with current dollars. Plus widow A never just shuts up and draws an income, widow A tries to meddle in all business decisions. Eventually the business pays widow A enough to buy her out after a lot of heart ache. Or, many times, it just shuts down

(I don't don't mean to be sexist, I know plenty of female business owners, it is just easier to be gender specific.)


Most businessmen and women I know aren't building a business for a spouse to take over upon his or her death. In fact I don't know a single businessman or woman that is building a business for the spouse to run. Some build it up for the kids, but if the businessperson expires before the kid is ready to take over what do you do without life insurance?

Taxes are really complicated and any rudiemntary knowledge of them is useless. You really have to understand tax law, hence you need a lawyer or a CPA. If you don't know the difference between a C Corp and an S Corp your opinions on who pays the taxes and what the taxes are is worthless. I will include my opinion, with my lack of knowledge when it comes to taxes, as worthless. I know just enough to know I shouldn't even begin to discuss tax issues in any detail.

 

[djs]

I'm not disagreeing that if the spouse / family wants the business, they should not enter into a buy/sell agreement. I am disagreeing that this has anything to do with life insurance.

If the family wants to sell the business upon the death, a life insurance policy is a practical way to pay for it. If the family wants to keep the business, then this makes no sense since they wouldn't have a buy/sell agreement in place. Again, the life policy is simply a tool to fund the buy/sell agreement, and has nothing to do with whether or not a buy/sell agreement is appropriate for any particular situation.

In many cases, the spouse/family would not want the business, and may not posess the knowledge to run it after the death of the owner. Their best bet is to sell it at the best possible value, which is as soon as possible. The buy/sell agreement just sets this up in advance, allowing the surviving spouse / family to have a lot less headaches in making this happen. It is part of a continuation plan.

Not for everyone, or every situation. It's a wonderful thing in the right situation, which in small businesses is probably pretty often.

Dan