Life insurance for business owners is common and incredibly important. Business owners may need life insurance on a person key to their company’s future. Business owners may need life insurance to fund a buy-sell agreement should something happen to one of the co-owners. Business owners may also need to use life insurance as collateral to obtain a loan.
In order to be approved for life insurance as a business owner, life insurance companies will want to review a financial history of the company. This will help determine how much coverage the business owner can purchase. It will also help assure the insurance company that the business owner is financially stable enough to keep up with the payments.
So what about start-up business owners?
Start-ups do not yet have financial records or a business history to submit to an insurance company for review. Because of this fact, many life insurance companies are hesitant to approve these applications.
It’s not uncommon for owners of start-up businesses to not take a salary for the first year or so in order to get the business up and running and have the ability to pay its employees. Seeing as insurance coverage justification relies on how much money a person makes, you can see why this situation poses a challenge for many life insurance agents trying to help their start-up clients.
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Start-up Business Owners Trying to Secure VC Funding
As a business owner looking to secure venture capital (VC) financing, the investors will want peace of mind and proof that their investment isn’t lost if you died unexpectedly.
Purchasing life insurance on yourself will help you make a case for why investors should put up funds for your idea. There is always risk in investing in new companies, but life insurance reduces this risk—at least a little bit.
But trying to purchase life insurance on yourself when you may not currently be making any income can be a struggle. We’ll discuss this further. Read on.
It’s important to note that oftentimes banks will say that you should name them as a beneficiary of your term policy. Don’t do this.
Start-up Business Owners Needing Coverage on Owners and/or Employees
When you’re in the beginning stages of getting your start-up up and running, your fellow co-owners and employees are key to the company’s success. If one of these people died suddenly, it may even mean the demise of your company.
One way to help cushion the blow of the death of a co-owner or key employee is to purchase life insurance on these individuals. If they should die, you’re provided funds to be able to cover expenses while you figure out next steps to take and hire a replacement. This strategy is known as key person life insurance.
Another strategy business owners commonly take is to buy life insurance to fund a buy-sell agreement if there is more than one owner of the company. This is when owners agree ahead of time how much each of their shares in the company is worth. Then they apply for life insurance coverage in at least this amount and either the company itself owns the policies or the co-owners own the policies on one another. If an owner dies, the life insurance proceeds are used to buy the deceased’s share in the company from the deceased’s estate.
For owners of a start-up, it can be difficult to obtain the necessary insurance coverage for a buy-sell or to insure a key person.
Jim, Stanley, and Pamela are working on launching their tech start-up. They’ve each devoted months to research and development and have begun to set meetings for VC funding. Each co-founder brings their own expertise to the company. If one of them died unexpectedly, replacing their skillsets would be difficult, to say the least.
They are looking to buy $1,000,000 key person life insurance policies on each other, but many insurance companies have declined their applications because they currently have no salaries (since they’ve been in the research and development stages) and don’t plan on taking salaries for another four quarters.
While they each have a track record of success, no bankruptcies, great credit, and extraordinary educational backgrounds, getting approval for millions of dollars in life insurance coverage is proving difficult.
We recently had clients come to us in very similar circumstances as the example above. But we have experience in these situations and our agents knew what to do.
The relationships we’ve developed with our life insurance companies are strong and we knew one company in particular might be convinced to approve coverage on our start-up clients. We had the agent on this case write up a detailed cover letter explaining the applicants’ history and reasoning behind needing the millions in coverage. After an in-depth evaluation of each applicant, the insurance company approved the key person life insurance policies on our clients.
Start-up Business Owners Applying for a Bank Loan
Not sure if you’re aware, but banks do not give out money unless they know they’ll eventually be repaid. Start-up business owners often do not have enough money sitting in their checking or savings account to get their business off the ground. They need to apply for a small business loan.
If you don’t have proof of income required to pay back the small business loan, how do you get a bank’s approval? This is, once again, when life insurance is beneficial.
It’s not uncommon to purchase life insurance policy on yourself as collateral for a loan. This way, if you were to die, the bank knows it will still get paid so they are much more willing to approve the loan.
It’s important to note that oftentimes banks will say that you should name them as a beneficiary of your term policy. Don’t do this. I say this because as you slowly pay off the loan, the balance owed also decreases; however, your life insurance policy’s death benefit does not.
As an example, let’s say you’re looking for a small business loan of $100,000. So, you get a 10-year term life insurance policy with a face amount (a.k.a. death benefit) of $100,000. You name the lender your policy’s sole and primary beneficiary.
You die in a tragic boating accident three years later with $65,000 remaining on the business loan. The lender then receives a check for $100,000 even though you only had $65,000 left to pay.
Instead, you should assign the bank as a collateral assignee on your policy. In this situation, if you die before the loan is paid off they only receive the amount that is owed. The remainder of your policy’s death benefit proceeds go to your beneficiary(ies).
Why Start-up Business Owners Should Work with Life Insurance Brokers
There are many great, financially strong life insurance companies out there. How do you know which one is best for your situation? A life insurance broker can help you figure that out.
Life insurance brokers do not work for the life insurance companies. They represent your best interests. Life insurance brokers, like Quotacy, have contracts with many different life insurance companies and, therefore, have the ability to shop your application around to get you the best rate.
As you’ve read, not all life insurance companies evaluate applications in the same way. They each follow their own calculated mortality risk guideline, which affects the types of risk they can take on and how much they charge.
If you’re looking for life insurance, Quotacy can help. Our agents are experts at navigating the world of life insurance and can find you the best policy. Start the process now by getting an anonymous term life insurance quote.
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About the writer
Writer, Editor, and Co-host of Quotacy's Q&A Fridays
Natasha is the content manager and editor for Quotacy. She has been in the life insurance industry since 2010 and has been making life insurance easier to understand with her writing since 2014. When not at work, she's probably studying and working toward her Chartered Life Underwriter (CLU) designation while throwing a tennis ball for her pitbull mix, Emmett, or curled up on her couch watching Netflix. If it’s football season, the Packers game will be on. Connect with her on LinkedIn.