No one dies with everything done.
That is especially true for business owners. There is always a contract in negotiation, a bank line of credit that should be revised, partners who will miss your knowledge and experience, a new customer to acquire, employees who need their job, a supplier who needs to hear about the flaw in the design, a government who would like taxes on your accrued gains, a family who could use some wealth independent of the business.
Business people often assume that the business value is enough to satisfy everyone should they pass away unexpectedly. They have never thought that through.
How much is a business worth if continuing management is not part of the deal?
All of the unfinished things will finish somehow. Most of them will be solved clumsily because your input and experience is unavailable. Clumsy means costly. Quick means costly. The best employees leave quickly. Inexperienced people solving problems means costly.
“Estate sale” means bargain.
In terms of the family security, the idea “The business is my family’s security” is near fraudulent.
Businesses with no management sell for much less than they would with continuing management. As one client once put it, “Anyone who has $6,000,000 and knows how to run this business is too smart to pay that much.” The buyer would have no adversaries bidding up the price. Half is not a bad guess for many complicated businesses run by their founder.
If your spouse had cash, would anyone advise her to use all of the money to buy a complex business with no management? Probably not, yet that is the advice she is getting when husband says, “The business is my family’s security.”
People misunderstand the purpose of life insurance.
Every estate needs cash. Some for taxes, some to equalize shares, some to make up for the lost asset value of a business, some for expenses, some for assets to protect a family’s lifestyle. Each of these assessments has a price. Each can be resolved by holding money. The key is getting the money.
There are exactly four ways for an estate to get the cash it needs.
The executor controls two of them:
- Sell something, Likely at a substantial discount
- Borrow against estate assets. Tying up the estate for a long time. Banks will want huge security if the value of assets is unclear.
The maker of the will controls two of them
- Hold cash assets while living. Huge opportunity cost and adverse taxation.
- Own life insurance
Owning life insurance is the optimal choice.
It is a capital budgeting decision and should be managed that way. Insurance is a solution to a problem. Insurance is not a cost, it is an answer to a problem. The problem is the cost and it behooves a person to compare the price of each of their potential solutions.
To understand the choices, work out what happens under each of the four conditions. Pick a point twelve months after death and see which of the four possible estates is bigger, more easily distributed, and easier to administer.
Life insurance works best because
Life insurance provides an immediate cash solution should death occur before the cassh is accumulated in other ways. Accumulating cash over 25 years is a fair choice if you live 25 years. Not everyone does.
Life insurance is a Type II tax shelter. No deduction for capital used, but no tax on accumulating value.
Life insurance is a very conservative investment. People who own risky business assets can balance their overall portfolio.
Life insurance takes only a small share of free cash flow to do the job. Having the life insurance needed for the estate allows people to seek greater returns with what they invest the rest of their money in. Liquidity becomes a non-issue.
Never overlook the easy answer
People like complexity and growth. Life insurance is dull. The advantage to dull is it works reliably.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. email@example.com 866-285-7772