We left off last week discussing why it’s important for individuals operating a business together to have a legal agreement that addresses what will happen with the business if either party becomes disabled. In this edition of Intentional Success, I speak to the issue of what will happen if one of them dies.
Assuming there is a yearly valuation process in place, each party will know how much his or her estate will receive in the event that he or she dies that year. An easy way to cover this off is with the purchase of life insurance. Assuming that both parties can get life insurance, then the solution is easy: the company buys the coverage and is the owner and beneficiary on the policy. The agreement says that the shares have to be redeemed by the company within 30 days and are exchanged for the life insurance proceeds (which is pretty simple if the correct funding is in place – which it should be if you make this part of your process each year and agree on it). If the valuation has gone up in a particular year, then you need to apply for additional coverage to fulfill the buyout upon death.
The only thing that can prevent this from happening is if one of the parties has lost his or her insurability. What happens if one is uninsurable? Is it still recommended to keep the insurable party covered? The answer is absolutely yes because this at least guarantees to the insurable party’s estate that a buyout will occur.
If you already have some coverage in place but not enough to cover the uninsurable party’s interest, then there will be a buyout with part of it covered by life insurance up front. The rest of the buyout conditions will be in the agreement on how many months or years that the remaining value (dollars) will be paid. The surviving party doesn’t have any new owners but does have debt outstanding that needs to be paid. The debt will carry an interest rate (pre-determined) so there is urgency for the debt to be paid off.
In the event the business is a partnership, then the policies are owned by each of the owners on each other’s life.
My advice to business owners is to always purchase enough insurance to cover all debts and the value of the business owners’ share. Also, you should make sure the accountant and lawyer are there to add their unique abilities for taxation and legal binding agreements.
In next week’s edition of Intentional Success, I will cover off the last two points of the agreement. Please watch for it!
Clifford A. Wiegers, CFP, TEP, Ch.F.C., CLU, B.Comm.
Insurance Representative, Wiegers Financial and Insurance Planning Services Ltd.
Financial Planner, Manulife Securities Investment Services Inc.
The opinions expressed are those of the author and may not necessarily reflect those of Manulife Securities Investment Services Inc.
Mutual funds are offered through Manulife Securities Investment Services Inc. Insurance products and services are offered through Wiegers Financial & Insurance Planning Services Ltd. Banking products and services are offered by referral arrangements through our related company Manulife Bank of Canada.