Protecting Your Business Legacy: Succession Planning Insurance

Succession planning involves identifying and preparing successors for a business. Transitioning a successor into a leadership role is challenging enough on its own – unforeseen disabilities, death, and other events can make it even harder. Proper planning goes a long way in helping businesses navigate operational disruptions, business failures, and probate conflict.

In this guide, we will go over key person insurance, buy-sell agreements, and other essential elements of succession planning.

The Role of Insurance in Succession Planning

Succession planning helps companies run smoothly even after key leaders and employees leave the company. As with all business strategies, succession planning comes with risks. A trigger event can severely impact ownership, succession, and buy-sell agreements. Common trigger events include:

• Death
• Disability
• Withdrawal
• Bankruptcy
• Divorce

Insurance serves to mitigate risks even when the unexpected arises. Let’s say a key individual in the company ends up passing away or retiring unexpectedly. This can lead to an instability that disrupts normal business operations for weeks, if not months.

Succession planning insurance can provide businesses with a payout in case of the unexpected. Depending on the type of business insurance obtained, the business could receive over $1,000,000 in an insurance payout following the death, disability, and/or exit from the company of a key individual. This money can be used by the business to recover from the sudden loss of the key person.

Let’s dive into what types of commercial insurance can help businesses improve their succession planning.

Types of Succession Planning Insurance Available

Different insurance products are designed for different succession planning purposes. Here are the main types of succession planning insurance solutions available.

Key person insurance

Key person insurance covers the death, disability, or lost of key persons within your company. Common key individuals include:

• Executives
• Founders
• Project leaders
• Creative directors
• Salespeople

Key person insurance is crucial for succession planning. It provides financial stability in the event of an unexpected loss of key personnel. Without key person insurance, losing a key individual in the company can lead to overwhelming financial difficulties.

Buy/sell agreement funding

A buy/sell agreement is a legally binding contract that is often crucial in any multi-owner business. Essentially, it designates how exactly an individual’s business shares will be sold to the company or other partners. Typically, buy-sell agreements are funded by the payout from life insurance. The successors or other partners can use the life insurance lump sum payout to buy the decedent’s stock.

Life insurance is:

• Cost-efficient
• Tax-efficient (life insurance proceeds are not taxable)
• Customizable
• Reliable
• Easier than loans or cash payments

A buy-sell agreement simplifies the process of what to do with a business share after someone exits the business or passes away. It helps the business avoid expensive probate court battles regarding the business shares.

If your business is structured to have multiple owners, a buy-sell agreement can ensure smoother transitions of ownership. The most common types of buy and sell agreements are:

• Cross-purchase: The remaining partners purchase the business share of the decedent.
• Entity-purchase: The business entity itself buys the business share of the decedent.
• Mixes of cross- and entity-purchase: The buy and sell agreement can be a mix of both forms depending on what the partners agree upon.

Buy and sell agreements also play a role in the succession planning of sole proprietorships, partnerships, and other ownership structures.

Life insurance

Life insurance can be useful for succession planning. Life insurance for businesses provides financial security to the family of the insured.

Businesses can use a life insurance policy as funding for a buy/sell agreement. The death benefits of the policy may be used to buy a deceased partner’s share of the business from their estate. In many cases, this reduces the ensuing conflict that can arise after the passing of a partner or co-owner.

Offering life insurance is also a good way to improve employee loyalty and morale.

Disability insurance

Disability buy-out insurance is a specific insurance policy that is highly recommended in business continuity plans. It serves to protect both business owners and businesses from financial challenges that arise in case of a disability.

Commercial liability insurance

Many legacy insurance packages offer liability insurance as additional protection for your company. This may include coverage for commercial general liability, isolated liability exposures, and other relevant liability.

Factors Influencing the Choice of Insurance Coverage

Business size

The size of a business will affect the optimal insurance product for your succession planning. A larger business typically comes with more complex succession needs and challenges.

Meanwhile, smaller businesses can afford to focus on simpler and/or fewer key person insurance policies.

Ownership structure

The ownership structure can greatly affect what type of insurance coverage you need. Business structures vary, such as sole proprietorships, partnerships, corporations, limited liability companies, and more.

Industry

Some industries and businesses face greater financial instability and reputational loss if a key person is lost. If your business has a front-facing employee or leader, their exiting the business could hurt your revenue and cause issues in finding a capable, new leader.

Market challenges can also impact succession planning and business insurance. Economic volatility, such as market downturns and recessions, can complicate the buy and sell agreements.

The valuation of a business can affect a buy-sell agreement or the insurance payout. Because of this, it is advisable for businesses to obtain the counsel of an insurance expert, attorney, and accountant when planning for succession. Partners will need to agree upon a business valuation, which may be determined through methodologies such as:

• Independent appraisals
• Earning-based valuation formula
• Compare with recently sold, similar companies
• Fixed price agreement

Specific succession goals

Does your business have any specific goals or visions related to succession? If so, it’s a good idea to tailor your insurance policy to cater to your specific goals. Here are common types of succession goals that can benefit from specialized commercial insurance.

Family ownership: If your business values being a family-owned business, a basic life insurance policy could be a cost-effective way to cover ownership transfer costs.

Mergers and acquisitions: If you’re looking to successfully close a deal selling your business, you can consider M&A insurance. This type of transactional risk insurance can protect you when it comes to the complexities associated with mergers and acquisitions. For example, insurance can mitigate risks related to ongoing litigation, taxes, and more.

Internal transition: Leadership often passes to existing employees, family members, or stakeholders. Key person insurance and life insurance are a good way to maintain continuity and financial stability in case of an unexpected loss of a leader or successor.

Cost

Business insurance premiums can be expensive depending on the policy limit and whether your business wants coverage for events other than the death of a key individual. Succession planning insurance for other trigger events, such as disabilities and retirement, will come with higher costs.

Consider your business’ revenue, the income of the key individual, risk factors, and budget when buying business legacy insurance. Poor succession planning can be devastating for companies of all sizes.

However, numerous insurance premiums can stack up and become a financial burden, especially for small businesses and startups with fewer resources. When choosing key persons to insure, it could be a good idea to prioritize insuring the most critical and/or elderly individuals within the business.

Policy term

Life insurance can be either a permanent life policy or a term life policy. Permanent policies offer coverage that does not expire, but will cost significantly more. Term life policies designate a certain period of coverage.

Succession planning involves determining which type of life insurance will suit your business needs best. Age, individual preferences, industry, and other factors can influence whether term-life insurance or permanent life insurance aligns better with your key persons.

Insurance company

The reputation and financial stability of a business insurance company are important to consider. Succession planning requires reliable business insurance policies that have a seamless claims process. In the event of a crisis or sudden loss of a leader within the company, a good business insurance company can grant the beneficiaries faster payouts.

In addition, your business may want to seek out customizable insurance products. Many businesses have unique needs and challenges, resulting in difficulty finding the perfect default insurance policy. A tailored, specialized policy can often better mitigate risks and bolster a succession plan.

Some of the best insurance companies include:

• Hiscox: An established carrier since 1901, Hiscox offers fast quotes with a quick claims process.

• Tivly: Get free commercial insurance quotes within minutes.

• Simply Business: Provides free, transparent quotes from top insurers. Get protection that is tailored to the needs of small businesses.

• The Hartford: Trusted by more than 1 million small businesses for their excellent commercial business insurance policies.

Best Practices for Integrating Insurance into Succession Planning Strategies

Assess and evaluate

Before purchasing insurance, the business should begin by conducting a thorough assessment. Consider your business structure, risks, leadership, and succession goals. By evaluating your different needs and risks, you can better decide what type of coverage your company actually needs.

The coverage limit of an insurance policy refers to the maximum payout. Insurance policies come with differing coverage limits depending on the type of coverage and your chosen plan.

When it comes to life insurance, the death benefit will be a key point of consideration. Life insurance payouts are often used to fund buy-sell agreements, so make sure to choose a suitable life insurance death benefit amount.

In general, businesses choose a key person insurance policy worth 5 to 10 times the key employee’s salary.

Regularly review and update insurance

As wonderful as it would be for insurance to be a one-and-done process, businesses should update their insurance regularly. New risks and needs can change what insurance your company needs. This is particularly important if your key personnel changes or your business goals shift over time.

Work with insurance professionals

When planning for something as crucial as succession, it’s a good idea to work with insurance experts to find the best products for your business. Business insurance experts can provide your company with individualized guidance every step of the way.

Insurance experts are important when devising buy/sell agreements and succession plans. If you have any specific succession goals or company needs, an insurance professional can help you design a tailored insurance policy for your business, protecting your interests as you plan for transitions of leadership.

Prepare contingencies

Insurance is great at covering the financial risks of unexpected incidents within the company. However, insurance in isolation is not enough to ensure a successful leadership transition.

Remember to prepare other contingency plans when tackling succession planning. It’s complicated business, looking into prospective replacements, researching market changes, and deciding on the type of succession.

The Harvard Business Review discussed how hiring outsiders tends to create more drastic shifts following succession – either providing or destroying massive value. An internal transition, on the other hand, comes with more stability. Regardless of whether a business wants to change the status quo when succession planning, make sure to have a plan of what to do in case it does not go well.

Summary

Succession planning is often filled with both overconfidence and doubt. Procuring business insurance is a good way to mitigate risk and prepare your business for a bright future. Succession planning insurance can:

• Grant large payouts in case of the unexpected loss of a key person
• Facilitate and fund buy-sell agreements
• Prevent financial and private disputes
• Prevent liquidity crises
• Ensure business continuity

Businesses should leverage insurance solutions to ensure continuity and protection for both current partners and future generations.