Businesses all over the world rely on loans to establish new ventures, inject capital into growing operations, or to fund many other aspects of the overall business. Business debt is part of the cost of doing business, and creditors may require that closely-held corporations personally guarantee repayment of this debt.
Small businesses, especially with sole proprietors or partners, are responsible for paying their business debt, regardless of circumstances. In simple terms, if the business’s own assets are insufficient to cover debts, such as loans, the sole proprietor must pay the difference out of pocket. Obviously, this can create significant financial hardships such as if the owner becomes disabled or dies unexpectedly. In this two-part article series, the role of business loan insurance will be introduced as well as giving business owners the details needed to make smart decisions about this vital insurance solution.
Unincorporated vs. Corporate Business Interests
Is it possible that a given company has to sign twice for any business loans they may take? Depending on the type of company, its configuration, and its ownership, the answer may be yes.
Unincorporated businesses, specifically those that exist under sole proprietorships or sole partners, are required by lending institutions to personally guarantee repayment of business loans. If the company’s own assets are insufficient to repay loan debts, the owner’s personal assets may be tapped to repay outstanding debts upon the owner’s death or permanent disability.
Corporations and corporate shareholders are typically shielded from some liability, particularly regarding limits to their capital contributions, but may still be required to secure loan repayment. Creditors evaluate these corporations using a complex set of metrics, taking into account the experience and management skill of the owners, to establish confidence that any loan will be repaid. Unfortunately, that experience and management skill may disappear in the untimely death of the owner or owners, and creditors may require additional assurances that the loan will be repaid in those circumstances.
Financial Hardships In an Owner’s Death
For businesses that have secured loans to expand their operations or to pay for equipment, properties, and infrastructure, the loan debt is a significant portion of overall expenses. Imagine, then, that the owner of a given company dies unexpectedly, and creditors seek to obtain repayment of outstanding loan debt. Financial hardships could be in store for the business and its surviving owners or partners – or even the owner’s family in the case of a sole proprietorship.
First, the remaining business assets may be targeted to repay the outstanding loan. Obviously, this can negatively impact the business’s ability to continue operations, and in worst-case scenarios, could force a sale or liquidation of the business and its assets to repay the loan. There are specific insurance solutions to protect against this, namely business overhead expense protection insurance plans, but not all companies take advantage of such solutions.
If the existing business assets are insufficient to cover debts, the owner’s personal assets are next to be targeted. Surviving family members may face significant hardships as a result; these personal assets were to be used to pay for living expenses of the owner’s spouse, children, and other dependents. A business loan debt can quickly exhaust these personal financial resources.
The Business Loan Insurance Solution
Faced with the possibility of business and/or personal assets becoming exhausted to repay a business loan in the case of an unexpected owner death, what can businesses do to protect themselves from these financial hardships? A potential solution is business loan insurance.
Business loan insurance is simply a life insurance policy purchased on the business owner’s life in an amount that matches the outstanding business loan debt. This type of policy is similar in some respects to other policies like key employee indemnification insurance. The policy is purchased on the owner or owners, partners, or key employees that are responsible for the continued success of the business operation. This insurance has many benefits and such a plan can accomplish:
- Prompt and certain payments, guaranteed by the policy’s terms. Proceeds become available immediately to repay outstanding business loans upon the owner’s death.
- The owner’s personal assets are protected, remaining available to surviving family members for their own expenses.
- The business’s own assets are shielded as well, allowing the business to continue unabated.
- Surviving owners (if any) are more able to continue the business operation without the financial burden of repaying outstanding debts.
- In general, life insurance proceeds under a business loan insurance policy are received without income tax implications.
- Proceeds in excess of the loan repayment can be used for other needs, such as providing benefits to the deceased owner’s surviving family members or to indemnify the business against the loss of skills and experience the deceased owner accrued during his or her career.
- Business loan insurance can provide small businesses with new opportunities, particularly in lines of business credit (new or expanded).
It is important to point out that the guarantee of proceed payments is based on the continued claims-paying ability of the insurance provider. As long as the insurer remains able to pay claims, business loan insurance remains the sole solution that guarantees the cash needed to pay outstanding loan debts in the event of an untimely owner death. This life insurance plan buys peace of mind, too, allowing the company to continue its operation without unnecessary financial burdens.
In part 2 of this article series, we will discuss how a business loan insurance plan works and the value such a plan represents to covered companies. Finally, we will provide a checklist that businesses can use to make smart decisions about their financial futures.
Article by Synergistic Life Services