Joint ownership is a simple reality of many small and medium size businesses.The aim of key person insurance is to insure business continuity. Partners, shareholders and lenders to small business can secure their investments by requiring key person insurance be taken by all the shareholders.
How it works
Consider this example; In a two person business, Jane and Peter have an equal ownership stake. As is often the case, an agreed “buy out” option exists that can be exercised by one partner upon the death of the other. This is often an arrangement between shareholders. If Peter dies, then Jane needs to “buy out” Peters share in the business. Problem is, Jane may be in no financial position to do this. If the business were to fund Peter’s buy-out, then Jane would be left with a “loan” in place of Peter as a shareholder. The other option for Jane is to find a new investor/partner to buy Peter’s stake. Otherwise Jane simply inherits Peter’s “family” as her new partner. In all scenarios, Janes bargaining power is limited and the continuity of the business is at risk.
However, if Jane and Peter had purchased life cover policies and made each other the benefactor, then on Peter’s death, Jane will receive a cash lump sum. This money is then used to buy out Peter’s share and can also be used to fund any loans or shareholder liabilities Peter may have been responsible for in the business.
Key person insurance… a simple solution for potentially a big problem J