What Are Key Man and Buy-Sell Arrangements, And Why Do You Need One?
By Les Stephen
Many small business owners have a few things in common. They tend to be very good at what they do (a master of their craft), but quite often struggle with the running of their venture as a business entity. Frequently, little consideration is given to the survivability and continuation of the business if something catastrophic was to happen to one of the owners or someone integral to the business. There are a few simple ways to insure against this with just a little planning.
Insurance, at its core, is generally used in situations where the chance of occurrence is LOW, but the financial cost of that occurrence is HIGH. For the costs of premium, you can shift the financial responsibility of these occurrences to an insurance company. Here are two situations where a business owner may want to not only shift that financial responsibility, but to also do some continuation business planning in the process.
What is Key Man Insurance
Key Man Insurance is a type of insurance coverage that a business owner purchases on a KEY employee or person in the business. It is an insurance policy taken to protect a business from losses arising from the death or incapacitation of an important person in the company. For example, consider a restaurant that has a world class chef who is the focal point of the business and the death or incapacitation of he/she would be devastating to the business. A Key Man policy would provide funds to help with the possible loss of revenue, training of someone to fill the position or the cost of hiring another world class chef to fill the position. Costs can be high if the employee is unhealthy or old: premiums can get expensive quickly and are dependent on your employee’s health and age, as well as their hobbies. Insurance companies underwrite the company as well as the employee, you’ll need to provide financial details about your business.
What is a Buy/Sell Agreement
A Buy/Sell Agreement is a contract that in brief spells out how a partner's share of a business may be reassigned if that partner dies or otherwise leaves the business. The most prevalent use of the buy/sell agreement would stipulate that the available share would be sold to the remaining partners or to the partnership. Imagine a situation where a 3-person medical practice suffers the loss of one of the partners and his/her portion is owned by the deceased partner's spouse that has no medical experience. Continuing a business arrangement with the spouse who cannot contribute to the day to day operations would be detrimental and may lead to dissolving the practice. Additionally, the surviving spouse could possibly seek legal actions for the proportional value of the practice. Having an arrangement in place funded by an insurance policy could make the funds available to buy out the spouse and allow the business to continue.
Of course, this an oversimplification of the explanation and examples of Key Man and Buy/Sell arrangements but hopefully it inspires some further questions. Once again, thanks for taking the time to read.
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The content in this article was prepared by the article’s author. Cetera Advisor Networks, LLC does not endorse its content, and the views expressed may not necessarily reflect those held by Cetera Advisor Networks, LLC.