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The Right Life Insurance for Each Stage of the Business Cycle

Becoming a business owner offers emotional and spiritual rewards to those involved. It’s a commitment of finances, hard work and long hours.

Once that commitment is made, all business owners go through comparable phases of life that match up with the life cycle of their business operation in terms of startup, growth, maturity and transitioning to new owners. Here is how you can match the right life insurance for each stage of that business cycle.


Stage 1 — Startup

A stage 1 business owner is in business for one to three years and is normally someone around 20 to 30 years of age with a young family.

Typically, their goal is to put together enough assets to start a viable business with the goal of surviving the early years while income is tight. In addition, it frequently means shouldering significant debt while plowing profits back into the company for future growth. Meanwhile, the owner needs life insurance for key person protection in case they or another important employee die.

Further, life insurance may be needed to cover business debts and to fund a buy and sell agreement with potential successors.

Typically, because cash is in short supply, term insurance is an affordable solution to meet each of these life insurance needs. The owner should consider buying convertible term coverage for the key person protection and the funding of a buy/sell agreement. 

Converting the term coverage to permanent protection (when it becomes affordable as the business grows) gives the owner flexibility that does not come with term coverage. For example, if a key person policy is converted from term coverage to permanent coverage and the key person lives to retirement, the policy can be sold to them, given to them as a supplemental retirement benefit, surrendered for cash or kept until the key person dies. 

Similarly, if a term policy funding a buy/sell agreement is converted to permanent insurance and the sale takes place on the owner’s disability or retirement, the cash value may be used as a down payment on the purchase price. Likewise, from a personal perspective, the business owner could use term or convertible term coverage to protect their family and name their spouse or a family trust as the beneficiary.


Stage 2 — Growth

If the business owner successfully demonstrates survival skills through the first three years in the business, the business generally grows. The owner usually is focused on expanding the business within the limits of their cash flow and available investment capital. In addition, they tend to pay down or pay off related debt. As their revenue stream is growing, they continue to need key person protection for themselves and any employees who are significant to the bottom line.

Further, funding for buy/sell agreements should keep pace with the business’s growing value, and overhead business expense should be considered along with disability insurance for the key people.

Finally, as the customer base is building, there is an increased need to focus on retaining valuable key employees through executive bonus or nonqualified deferred compensation plans. Executive bonus plans using cash value insurance have the advantage of being the simplest and easiest employee benefit plans to set up and administer, but since the employee has unfettered ownership of the policy, it is not acting as a “golden handcuff” to keep the employee around.

Conversely, restricted bonus arrangements are a more effective way to retain a valuable employee. To receive the employer’s premium contributions, the employee must agree not to touch the policy’s cash value until a triggering event, such as the passage of a certain period of time. In addition, the employee must agree to pay back the employer’s premium advances if the employee leaves early.

Nonqualified deferred compensation plans, which typically are funded informally with life insurance, are also good for retaining valuable employees. However, they are much more complicated to set up and administer, and have specific limitations on when the employees may have access to the funds.

On the personal side, the owner’s financial success at this stage of the business cycle means they are most likely interested in maintaining a comfortable lifestyle for their family if they die. This typically requires life insurance coverage adequate to provide spousal support, mortgage protection and college funding for the children.


Stage 3 — Maturity

In this phase, the business is now established in the market. It has a solid management team with a consistent cash flow that can support ongoing key person coverage, overhead and disability insurance, key person retention plans and ongoing business exit strategies (life insurance-funded buy/sell agreements).

At this point, the owner needs to think about doing their retirement and succession planning because of their advancing age and the important relationship that exists between these two objectives. Their financial success means that now more than ever, they have more to lose. Proper planning that should focus on business succession and family support, often for their parents as well as their adult children, is now a concern.

Another possible need at this stage of life might be estate tax planning. The federal estate tax applicable exclusion for 2017 is $5,490,000 per individual. This means that if the business owner individually has wealth in excess of $5,490,000, or more than $10,900,000 as a married person, they have an estate tax exposure.

To deal with that, they can engage in various estate tax-saving techniques that may be used to reduce or eliminate their estate tax exposure. These approaches have two things in common: They often require the business owner to change how they own or manage their property, and  they often require the owner to engage in large estate-reducing gifts. These obstacles may be met with resistance from the owner, as they can be resistant to change.

Consequently, if the owner is opposed to making changes in how they own or manage their property, they may engage in the more palatable alternative of simply prefunding any potential estate tax liability with life insurance purchased through an irrevocable life insurance trust.


Stage 4 — Transitioning

At this stage, the owner is in their late middle-aged and inclined to rely on what they have already built over the years for their financial support. While they may not be particularly interested in growing the business, they realize that inaction may result in the eventual decline and termination of the business to their detriment. Consequently, they see the need for transition planning to new owners as being paramount.

Business owners typically plan their retirement around the assumption that they can sell their interest in the enterprise. The problem with this kind of thinking is that  selling an interest in a closely held business is not like selling a share of publicly traded stock on an established exchange. Instead, it typically requires a period of two or three years during which the business must be prepared for sale or other disposition. 

This involves creating a plan to package and market the business to suitable successors and can involve addressing certain preliminary life insurance needs regardless of the business exit strategy adopted. Consideration should be given to maintaining any bonus or nonqualified deferred compensation arrangements that were designed to retain key employees, since their presence is essential to maintaining the value and salability of the business during the transition to new owners.

In addition to the possibility of key employees leaving the company, there is also the risk that such people might die during the transition period. To protect the business owner and prospective successors from this risk, any key person coverage should be continued.

Since all business owners face the fact that they eventually will die, retire or become disabled, it is wise for them never to leave themselves or their family in a position where they do not know what will happen to their business if any of these things happens.

One last thing to keep in mind.  If the business owner’s exit plan is to transfer the business to one or more children, but not others, that leaves the question of how to deal fairly with the children who will not receive an interest in the business. The way to make things equal is to have the business owner purchase life insurance on their life, and make the children who are not to receive an interest in the business the beneficiaries. This way all of the children may be treated equitably or fairly.  


Louis S. Shuntich, J.D., LL.M., is director, Advanced Consulting Group, Nationwide Financial. Louis may be contacted at [email protected] [email protected].

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