Going into business with one or more other people requires somewhat of a leap of faith. You count on those partners to pull their weight and agreements are made as to what duties will be covered by whom. However, no amount of handshakes and contracts can prepare you for when disaster strikes. Your business partner could die in a car crash or be sidelined by some medical problem that puts them out of work for months, or forever. They could even land in jail or a bitter divorce could wipe out many assets. This is why taking out insurance on your business partner can be crucial to keeping the business afloat during such times.
My Personal Story
Just a couple of years ago, I had a very close family member who was diagnosed with brain cancer and died just five months after the initial diagnosis. He had been suffering from severe headaches and decided to take the afternoon off from work to see a doctor and figure out what was wrong. Two MRIs later, because his doctor was in such disbelief that he thought the machine had malfunctioned the first time, my relative was found to have a very advanced growth that had spread all over his brain, and treatment began immediately. He never went back to work again.
This family member was a partner in a business that had been around for a couple of decades, and it employed about a dozen people. As part owner, he owned a 20% stake in the company, as well as the office building, the attached warehouse, the property it all sat on, some company vehicles and even a boat used to entertain clients. He was also one of the main sales persons and brought a lot of money into the company every month. His absence was felt immediately, and in more ways than one.
Luckily, the company had a key person insurance policy and was able to keep going after the untimely passing of my relative. They did not, however, profit from his death.
Key Person Insurance
A key person insurance policy, sometimes known as a key man policy, is a type of insurance that protects against the loss of a business partner. It serves two main purposes:
- To help cover the lost income from that partner.
- To enable the other partner(s) to buy out the heirs of that lost partner.
The first purpose regarding income is a given. One less person doing work means less money coming in. In the example discussed above, the company still had ongoing sales that were coming in after my family member left work, but they lost out on many new orders and the other sales persons had to take up the slack. They couldn't afford to hire another sales person and weren't sure when my relative could return because there is so much uncertainty with cancer treatment.
The second purpose of this policy is most important, in my opinion. Because my relative had a 1/5th stake in the company, that ownership was transferred to his wife after he died. His wife already worked another job and had no interest doing sales or even in being part of the company, so this meant the partners needed to buy out her share. Otherwise, they'd have to work out some kind of rental agreement or put her on payroll.
I won't say what the total amount of the policy covered, but imagine what 20% of an office building, warehouse, downtown city property, vehicles and a boat would be worth. On top of that, you have to consider the ownership part of the business itself. It's like buying someone out of their job. How much would it take to make someone give up a job? That's very much how a buyout like this works.
Lawyers and accountants had to get involved before it was all over, but a fair deal was reached and the remaining partner bought out the wife's stake in the company. By the time it was all over, very little of the money from the insurance policy remained. The company would very likely have gone under if they didn't have that cash on hand.
Protect Yourself and Your Business
Insurance is one of those necessary evils that nobody likes to pay, but it can be a life saver when you actually need it. You can pay homeowner's insurance for years and then suddenly a hurricane hits and you'll be glad you have it. The same goes for medical insurance when you pay for services that you might not need for ten years then suddenly a diagnosis turns into tens of thousands of dollars in medical bills. The very same goes for a business. You never know what can happen from day to day, and not having proper protection in place can be so costly that it could end the company.
In the real life example discussed above, my family member's business partners were able to save their business because they had sense enough to take out an insurance policy to protect them in case of disaster. Are you willing to gamble on your future with your own partners, or should you make that call and get a policy in place just in case something happens? My relative had no idea what awaited him when he walked into that doctor's office with what he thought was just a bad headache.
- Image credit: AnthonyR, After Hours, http://www.sxc.hu/photo/1237234
- MEG Financial, Key Man Insurance, http://www.keypersoninsurance.com/key_man_insurance.php
- Author’s personal experience and education.