The decision to liquidate a family-owned business is not one to be taken lightly. The death of a business owner, or a situation where the owner becomes disabled and is no longer able to manage business operations, can cause family members to feel pressure to divest themselves of business assets. This can have long-ranging negative effects.
In the first part of our series on business liquidation insurance, we discussed two potential scenarios, that of a forced liquidation or of a planned business liquidation. We also talked about some of the difficult decisions surviving family members must make regarding the future of the business or its sale. In this part, we will introduce the concept of business liquidation insurance, particularly the role of life insurance in buying time to dispose of the business assets in an advantageous manner.
Considerations on Business Liquidation Insurance
There are many types of insurance, including policies that protect business assets as well as life insurance policies designed to provide income after death or disability of the policy owner. For the purposes of this discussion, life insurance is the focus for business liquidation purposes.
As mentioned in our previous installment, a planned (or unplanned) business liquidation requires that the owner’s executor and/or family members need time to address the sale of the business, helping it to command a sale price that is fair and adequate. Rushing into a quick sale of a business after the owner dies or becomes disabled, or being forced into such a situation due to the lack of funds after the owner dies, can result in significant loss of value. Life insurance may be the solution that buys time.
In the Event of a Business Owner Death
When the liquidation of a business and its assets become the sole course of action when a business owner dies, life insurance can provide the financial liquidity needed to plan the sale of the business. Without adequate funds, the family of the deceased or his or her executor may be forced into a sale, creating a potential financial disaster for surviving family members. Life insurance can be put to use in several ways during a planned business liquidation:
- Proceeds from a life insurance policy can be used to pay estate costs, such as taxes and settlements. This buys time, allowing the business assets to be liquidated in an orderly and equitable manner.
- Funds from a life insurance policy can continue to provide an income for surviving family members, particularly when those loved ones depended on the business for their livelihood.
- In some cases, the executor wishes to operate the business on a temporary basis prior to liquidation, funds from a life insurance policy can make that possible.
- Proceeds from a life insurance policy can help to offset some of the lost value in a business liquidation. Even planned liquidations face a significant loss in value, especially when compared to the business value when it was fully operational. Life insurance proceeds replace this loss in value, creating financial stability for surviving family members.
In simple terms, only life insurance policies can protect a family’s financial future in the case of a business liquidation. The guaranteed funds from such a policy can stave off a forced liquidation, allowing family members or executors the time needed to make smart and advantageous decisions on the sale. Of course, the guarantee is dependent on the claims-paying ability of the policyholder and the insurer itself.
Insurance in the Event of Business Owner Disability
The disability of a business owner can take many forms. An owner may become disabled for a short period of time or may face a long-term or even permanent disability. It goes without saying that any disability severely impacts the owner’s ability to conduct business, and in many cases may result in the need to liquefy the business and its assets.
When a disability occurs, a business owner and his or her family will want time to make tough decisions about the future of business operations. As in the case of an owner death, life insurance buys critical time for the planned liquidation to occur.
For a short-term disability, it can be useful to consider the following scenario: imagine the owner wishes to keep the company operating while he or she recuperates and to avoid a forced business liquidation. As might be expected, business expenses continue to accrue, and the need for an income is paramount. Two special types of insurance policy may be valuable in providing continuity of business interests. In the first, business overhead expense insurance can be used to reimburse costs incurred by the business owner during a short-term disability. Disability income insurance is similar in that these policies are designed to provide income, especially lost income due to the disability.
Longer-term disability considerations are also similar. Loss of income can mean a forced business liquidation, and funds are needed to put an advantageous liquidation plan into place. In the case when a business owner is sick for an extended period of time and unable to work, disability income insurance serves as an income replacement. This helps provide the time needed to make decisions about the future of the business, such as who it will be sold to, its fair sale value, and when the sale may take place.
An Action Checklist for Business Liquidation Insurance
Now that we’ve learned the value of life insurance in buying the time needed to liquefy a business, an action plan can be useful. In the following checklist, there are three components: implementing a life insurance plan, implementing a disability insurance plan, and conducting an annual review of policy coverage.
Implementing a Life Insurance Plan:
- Determine the amount of funding needed to avoid a forced business liquidation.
- Choose the appropriate life insurance policy to meet these financial needs.
- Establish the business owner’s insurability.
- Make decisions about premium payments, such as the best arrangement for paying to ensure continuity.
Implementing a Disability Insurance Plan:
- Investigate the types of available insurance plans and the amount of coverage needed to avoid a forced liquidation of the business.
- Select the appropriate policy or policies for the specific needs of the business owner and his/her family.
- Establish insurability of the business owner.
- Decide about premium payment arrangements.
Smart business owners know that circumstances change. Because of these changes, it is critical to review insurance coverage, policy premiums, and specific terms on an annual basis. The guidance of a qualified insurance agent can be greatly beneficial during this review, helping business owners make the financial decisions needed to ensure a smooth business liquidation if the situation arises.