Use life insurance for business transactions

Life insurance is a powerful tool that many people only see the surface of. Life insurance is typically used to finance someone's death and support remaining family members.

For Powers & Sons Construction, a partnership with an insurance company became the means to start building single family homes in northwest Indiana. The story starts with Mamon Powers, Sr.'s move from Mississippi to Gary as part of the great migration.

After becoming the first Black apprentice in Indiana, Powers then worked for an African American real estate developer who led the way in constructing quality housing for the Black middle class. In 1967, Powers started his own company and continued building homes on the west side of Gary.

But there was a problem. Many banks in the 1960s would not lend to Black entrepreneurs. Through his business relationships, Powers was able to form a strategic partnership with an insurance company that loaned Powers the capital to build predominantly Black neighborhoods.

Using life insurance as a means to grow business may function differently today, but the same premise applies — entrepreneurs can use life insurance as a vehicle to fund business acquisition, business growth and mitigate risk and maintain control of a company when an owner dies.

There are two specific modern-day instances where life insurance can be used to support business continuity, transition and acquisition.

First, permanent or whole life insurance plan owners may make a withdrawal from the cash value of their plans to make self-directed investments.

For example, if you have a life insurance policy with $50,000 in cash value, the policy owner may be able to take a loan against the value and use it for the down payment on a business. To use that cash to purchase a $500,000 business, an entrepreneur would deploy the $50,000 to acquire the company with 10%-down on a SBA loan. If the business produces 10% profit on $500,000 in sales, the $50,000 loan from the life insurance policy could be paid back in a year.

However, this is not realistic. Most business owners will use profits for working capital, capital investment, cash retention, owner distributions and debt service. As a result, only a portion of profits may go toward paying off the loan (debt) from the life insurance policy. Savvy entrepreneurs will make a multi-year plan for debt repayment to the policy.

Second, business owners can use life insurance to fund the purchase of shares in the business if an owner dies.

Let's say that you have two partners in a business and Partner A dies. In many cases, unless a buy-sell or operating agreement specifies otherwise, Partner A's shares may transfer to their family members. This means that Partner B is suddenly in business with Partner A's spouse, children, or others. An alternative is for Partners A & B to take out whole or term life insurance policies. The policies are paid for by the business. The beneficiary of the policy is the business.

So, when Partner A or B dies, the company receives the insurance proceeds to buy the shares of the business back from the heirs of the partner. A strong buy-sell agreement between the partners will also make provision for the process of how the buy-back of shares should be handled after the death of a partner. In addition, if the policy is permanent or whole life, the owners may be able to take a loan against the value of the life insurance policy to invest in their current or additional businesses.

For entrepreneurs, life insurance is not just a tool to protect families and assets after death — it is a powerful means to acquire companies, invest in growth opportunities and protect a business's interests.

Jamar Cobb-Dennard is an attorney and business broker. To learn more about how to buy and sell businesses, contact Jamar at [email protected].

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