What would happen to your insurance agency business if you died tomorrow?

Owners continually strive to grow the value of their businesses. It’s critically important that the monetary value created in your business is preserved, in the event of your unexpected death or if you suffer a permanent disability. The financial security of your family should not be dependent upon your long life and good health.

Death or disability should be viewed as an exit path that requires the same level of planning and execution, as does a sale to a third party or a lifetime transfer to family members or employees. Ask yourself the following questions:

• What happens if I die or become permanently disabled tomorrow?
• Will my family be able to maintain the lifestyle I want for them?
• Will my business survive?
• Will my business be able to be sold or transferred in a financially responsible manner?

If you are deeply involved in your business, your death will cause your employees, customers, vendors, and bankers to reevaluate their relationships with your company. Your key managers are likely to be solicited by your competitors, and your bankers and vendors are likely to seek a replacement for your personal guarantee. Unless you have implemented certain measures to assure a minimal disruption of your business, your death may result in a mortal blow to your business.

Critical steps to preserve the value of your business

There are steps that should be taken to preserve the value of your business. These steps are critical, if you are a sole owner. If you are a co-owner, these steps may also prove to be valuable.

• Implement a stay-bonus plan for your key employees. Offer your employees a fixed-sum bonus to remain employed by your company, in the event of your death or permanent disability. Their continued employment can be for one or two years, or through the sale of your company. If the employees stay with your company for the predetermined period, they receive a significant bonus (typically 30% to 60% of annual salary) at the end of that period. The bonus can be funded with the life insurance on your life. The funding of the bonus with insurance will put the key employees’ minds at ease that the funds will be available when they are required to be paid.

Stay bonuses work particularly well, if upon your death the goal is to sell the business to a third party. Alternatively, if you want your family to retain the business after your death, consider long-term cash-based incentives for non-family members. The creation of a Phantom Stock Ownership or similar non-qualified deferred compensation plan will meet this objective.

• Address capitalization. Unless you are able to sell your business quickly, you will likely need to substitute cash for your personal guarantees, with respect to bank loans and lines of credit, leases, surety bonds, and vendors. The purchase of life insurance in an amount sufficient to pay down a portion of these obligations, and therefore reduce the financing party’s exposure, is generally the preferred course of action.
• Create a business continuity instruction form. This form instructs your family, key employees, and advisers of your wishes, regarding the continuation of your business. The continuity instruction form should, at a minimum, contain the following critical information: (i) account numbers and passwords; contact information for each trusted adviser; your preferred disposition of the business; and the roles and responsibility of each member of your management team.

Co-owners: Do you have a current Buy-Sell Agreement?

If you are a co-owner of your business, then hopefully you have a current Buy-Sell Agreement. One of the great benefits of a current Buy-Sell agreement is that it enables the business to continue when one owner dies. I often find that Buy-Sell agreements have been drafted many years ago and have never been reviewed or revised as the business has grown. An outdated Buy-Sell can be worse than having no agreement at all.

Related: Less than half of surveyed independent agents have a perpetuation plan for their businesses

A properly drafted and funded Buy-Sell will have: an agreed-upon value of the stock or membership interest; a source of funding for the buy-out; and agreed-upon buy-out terms. Term life insurance is ordinarily used as the source of funding for a buy-out, upon a death of a co-owner.

A Buy-Sell Agreement should generally treat the permanent disability of shareholder in a fashion similar to how it treats a shareholder’s death, since both events should cause an ownership transfer. If affordable, use disability buy-out insurance to fund part of the buy-out (name the company as beneficiary), and disability income insurance to partially replace lost income.

Challenges of successfully transferring a business at death

It’s important to note that even with a Buy-Sell Agreement that reflects the full ownership value, the income from the sale proceeds will likely only be a fraction of the amount your family needs to replace the income currently provided by your business. The creation of a trust to own additional insurance on your life is advisable to replace the shortfall in income.

The goals and challenges of successfully transferring a business at death are, in many cases, the same as those of a transfer during an owner’s lifetime. A plan needs to be put in place to ensure that your lifetime financial, business, and personal goals are attained, if you do not make it to your planned departure date.

Related: 3 top succession strategies for agency owners: Which one’s right for you?

Marc Solomon (msolomon@wsh-law.com) is partner at the firm of Weiss Serota Helfman Cole & Bierman P.L. He serves as the chair of the firm’s corporate department.