In this episode: Building wealth means protecting it. Jon Peyton focuses on the two business coverages owners most often overlook: key person insurance, which protects the company if someone essential becomes disabled or dies, and insurance-funded buy-sell agreements, which let partners buy each other out on fair terms.
Key insights
- A business may need many coverages, but key person and buy-sell protection are the ones owners most often skip.
- Key person coverage, through disability or life insurance, can fund a replacement or serve as a “golden handcuff” benefit for a valued employee.
- Owners need disability coverage too. Few businesses run as well without the owner, and a lost income is hard to replace.
- A buy-sell agreement lets a surviving partner buy out a deceased or disabled partner’s family, so no one ends up in business with people they didn’t choose.
- Valuation is where buy-sells get sticky. Spell out how value will be set and what happens if coverage falls short.
Episode timeline
- 0:00 Protecting the business with insurance
- 1:29 The many coverages a business may need
- 2:42 The two most overlooked: key person and buy-sell
- 2:53 Key person disability coverage
- 5:42 Key person life coverage and golden handcuffs
- 7:24 Does the owner need coverage too?
- 8:45 Lessons from the pandemic
- 9:45 Funding your replacement if you die
- 15:12 How a buy-sell agreement works
- 16:43 Why valuation gets sticky
- 19:36 Multiple valuations and funding gaps
- 22:22 When a partner becomes disabled
- 25:31 Using these tools for executives and owners
The episode in brief
Protection comes in many forms. Contracts and patents protect a business, and so does insurance. Owners may need errors and omissions, business overhead, loss of use, health, disability and other coverages. Jon focuses on the two he sees overlooked most: key person and buy-sell.
Key person coverage. Every business has someone who holds things together. Key person coverage, through a disability or life policy, protects the business if that person can’t work. With disability coverage, the policy replaces much of the person’s income, freeing the business to fund a replacement. Structured as a benefit the company pays for, it can also act as a “golden handcuff” that encourages a valued employee to stay. Who owns the policy, who pays and who receives the benefit all change how it works and how it’s taxed, so design it with professionals.
The owner needs it too. If you’re the primary earner and your business wouldn’t run as well without you, disability coverage protects your family’s lifestyle. Jon has seen clients go six to nine months without income. During the pandemic, many owners learned their reserves weren’t enough, and emergency government programs won’t always be there. If you die, a key person life policy can give the business enough capital to hire a replacement while your family keeps drawing income, buying years of runway and keeping the business from a fire sale.
Buy-sell agreements. Partners usually don’t want to end up in business with each other’s spouses, and families usually want cash, not a stake in a company they can’t run. A buy-sell agreement, often funded with life or disability insurance, lets the surviving partner buy out the family’s interest so everyone gets what they need.
Valuation is the sticky part. Private businesses are hard to value, and their value can change quickly. Partners may disagree, and a family may expect more than the business is worth when the time comes. Spell out in the agreement how value will be determined, for example by averaging independent valuations. Also decide what happens if insurance doesn’t cover the full price: a payout over time, or a reduced ownership stake.
Disability among partners. If a partner becomes disabled, a policy that replaces their share of profits, possibly paired with a structured buyout, avoids the resentment of one partner growing the business while the other collects. These tools help executives negotiate better packages and help owners protect their families and partnerships.
Key action items
- List the key people in your business. Note what it would cost to replace each one, and whether coverage exists.
- Check your own disability coverage. Confirm how much of your income would be replaced and for how long.
- Review your buy-sell agreement. If you have partners, make sure it exists, is funded and spells out how value will be set.
- Bring in professionals. Have an attorney, CPA and licensed insurance professional design ownership, funding and tax treatment together.
Listen next: Episode 28: How Entrepreneurs Should Use Insurance to Protect Themselves
Value Creation Consultancy™ has since merged into Founder’s Accounting™.
This episode is educational and isn’t legal, tax, insurance or financial advice. Speak with your own attorney and advisers about your situation.