Life Insurance Solutions for Small Business Owners

Life Insurance Solutions for Small Business
Owners - Part 1
From Manulife

Small businesses fail for a number of reasons, including lack of planning, poor management,
inadequate funds, downturns in the economy, debt overload, etc. As you work through your
business plan, you'll be looking for financial solutions that bring your business stability to
situations where you can be particularly vulnerable. You should plan for the unexpected.

Life insurance can provide a cost-effective solution for many situations that could threaten a small business, such as the loss of an owner or a key employee. This section provides an overview of how life insurance can be used to help a small business plan for the unexpected, including:

• Key Person Insurance
• Business Loan Protection
• Buy-sell Funding
• Funding Capital Gains Tax on a Business at Death
• Split Dollar Arrangements

We also look at how life insurance can provide small businesses with an opportunity for tax-advantaged investing and how it can be used as part of an enticing compensation package to attract the best employees.

Key Person Insurance

Business owners and other key executives spend considerable time and effort to acquire the knowledge, experience, judgment, reputation, relationships and skills that make them valuable to the business. When they die, the business loses a key member of the management team
and this can have a severe financial impact.

During the disruption that follows the death of a key player, lenders may cut back credit, creditors may press for immediate payment, debtors may delay making payments, employees and customers may lose confidence, and competitors may take advantage of the situation.

Large corporations are often in a much better position to prepare for key executive turnover because of sheer size and numbers. Unfortunately, in small business situations, finding an immediate replacement with the same qualifications as a deceased owner or executive is much
more difficult.

It is often necessary to look outside of the business to find a replacement, causing delays, disruption and reduced efficiency. The resulting effect on business profits may further weaken the financial stability of the business. In the absence of proper planning, the very survival of the
business may be affected by the death of a business owner or a key executive.

The impact of this situation can be considerably reduced if the business has purchased an insurance policy on the life of the business owner and/or key executives. If they die, the
life insurance proceeds give the business working capital to meet immediate cash needs and provide a source of funds for finding, attracting, hiring, and training a replacement for the deceased executive or to hire interim management.

Key person insurance provides assurance to a small business’s creditors and employees that the business will continue even if a key person dies. The life insurance proceeds provide immediate cash to cover the business’s working capital needs and to find and train a suitable replacement for the person who died. The value of these benefits to the business should far exceed the cost of the life insurance.

Business Loan Protection

It can be difficult to obtain adequate debt financing for a small business. Creditors will often require the business owner to personally guarantee a loan. The death of the business owner or another key executive may cause creditors to demand immediate repayment of outstanding
business debts.

This can place a significant burden on the business and force the liquidation of key business assets at fire sale prices at a time when business results may already be severely impacted by the death. In addition, if the business owner has personally guaranteed the debts incurred by the business, the owner or the owner’s estate may be liable for any outstanding debts that
the business is unable to pay. If effective planning hasn’t taken place, the business may
not survive the owner’s or another key executive’s death.

A solution is for the business to purchase an insurance policy on the life of the business owner(s) or other key executives. Proceeds from the life insurance policy are taxfree and may be used to pay down the outstanding business debts.

A creditor may require a small business to purchase collateral life insurance to protect the creditor’s interests, particularly if the death of the business’s owner could affect the value of business assets used to secure the debt. In other cases, the business owner may simply want to ensure that business debts will be fully repaid if he or she dies to minimize financial risks for heirs and to permit the business to continue free of debt.

Generally, life insurance premiums paid for business loan protection are not deductible for tax purposes. However, if a life insurance policy has been collaterally assigned to a restricted financial institution, a portion of the premiums may be deductible.

A life insurance policy purchased for business loan protection can help a business negotiate loans and repay business debts with tax-free life insurance proceeds when a a business owner or another key executive dies. It can also prevent business owners or their estate from becoming
personally liable for the business debts if the owner dies.

www.manulife.ca

For more information, email us, visit our website or call our in-house Financial Advisor Bob McIntosh at 1-800-419-3723