Many small businesses are highly dependent on the presence of a key employee or small group of employees for the ongoing operation of their business. It may be an owner, partner, or some other principal in the business. Protecting your business against the untimely death of that person with some type of life insurance policy can be wise. In fact, some lenders may require such an arrangement.
Here are some questions to help determine if you may need this type of insurance protection:

• What would happen if one of your key employees were to die?
• Would your business cease to operate?
• How would your operations change?
• Is there another key employee to take that person's place?
• How much would it cost to hire another person to fill the void?

If answering those questions raises red flags, you should consider buying life insurance on that key employee. That way, you will have funds available to help run the company until a replacement is found or another resolution is determined. The best policy could be a relatively inexpensive term life insurance policy. The business would be both the policy owner and the beneficiary, and would pay the premiums on the policy. If the key employee dies, the company receives the death benefits and can then decide on a future course of action.

Using Life Insurance as Part of a Buy/Sell Agreement

Buy/sell agreements control what happens to an ownership interest in the event of the death or disability of one of the major owners of a business. They can be structured so that, upon the death of an owner, the business buys back their interest or the remaining owners buy the interest. In most cases, buy/sell agreements include some valuation guidelines for the business.

Many companies use life insurance as a means to fund these types of agreements. For example, if the business is valued at $3 million and one owner has a one third stake in the business, the business may buy a $1 million term life policy. The proceeds could be used to buy the deceased owner's shares upon his death. Another option would be for each owner to buy policies on the lives of the other owners. There are some special tax rules that apply to corporate ownership of life insurance policies. If you are considering this type of arrangement, be sure to seek qualified legal advice.