20
STAR*TECH JOURNAL/JUNE 1983
SOIB PROPRIETORSIIlP LIFE INSURANCE
by S. GUTTENTAG
Many operators are the sole owner-managers of
their businesses. The following article outlines
certain avenues you can explore for insuring your
business concerns.
WHAT THE ONE-MAN
BUSINESS FACES
There are more sole proprietorships than any other
form of business organization in the United States.
It is estimated that more than 70 percent of the
nation's retail, manufacturing, wholesale and service
businesses are owned and managed by one person.
In most cases, the state laws provide that, upon
the death of a sole proprietor, his business becomes
a part of his estate, to be administered by his
executor or administrator and passed along to the
heirs as quickly as possible - unless otherwise
provided.
Thus, it is clear that the family and heirs of the
owner of a one-man business face the possibility of
loss, even liquidation at severe sacrifice, unless
some specific plan is set up in advance of death, to
assure future operation of the business, if it is to be
continued.
If the proprietor dies, a number of things can be
done.
1. The business can be left to the son, widow or
other heirs.
2. It can be sold to the employees.
3. It can be sold to outsiders.
4. It can be continued by the executors or trustees.
5. It can be liquidated.
PROBLEMS
Each of these procedures, unless set up under a
carefully drawn plan, raises problems for the sole
proprietor's heirs. Sale might be forced by either
cash needs or demands of heirs and a forced sale
could result in severe Joss.
If the executor were to run the business, he
would hire a manager who might not do the best job
possible. Among other things, this manager would
know the work was temporary.
The son or other heir might not be qualified to
run the business. The heir might still be a minor,
might have friction with other heirs or with
employees, or might be handicapped by lack of
working capital or credit.
If the business is transferred to employees, or
outsiders, there might be controversy over valuation.
Or there may be trouble over availability of funds
to carry out the transfer.
Delays caused by administration, even where
there is a will, could cause serious losses. Any
change could disturb customer goodwill and
employee morale. It could create credit difficulties.
The sole proprietor who is interested in selling
his business to his employees should consult with
an attorney and a life insurance underwriter about
the possibility of combining a pension or profit-
sharing plan with a purchase agreement. Such a
plan can be funded by life insurance on the life of
the business owner.
NEED FOR FUNDS
Whatever disposition is to be made of the business,
there will be need for funds. Debts, taxes and
administrative costs have to be met. Income for the
family has to be provided.
If the family is continuing the business, someone
will probably have to be hired to manage the
business. And working capital will be needed, at
least for a period of readjustment.
If employees are to take over, funds for their
purchase of the business have to be made available,
at least in part.
If the business is sold outright, working capital
will be needed for the transition period. Perhaps
some funds may also be needed to meet the
probable discounting of assets which accompany
such a sale.
IMPORTANCE OF THE TIME ELEMENT
Most of these funds are needed quickly - more
quickly than they could be provided by the sale of
the business unless through a forced sale, in which
case there would almost certainly be a loss. The
tax needs are urgent and cannot be avoided or
postponed. Credit needs are likely to be even more
urgent, if the business is to be maintained during
the transition period.
Depending on the type of business involved,
there is likely to be an immediate need for working
capital. A grocery, for example, dealing in perish-
able goods, might require capital for immediate
use.
A business of a highly specialized type might
find it so difficult to find a buyer that substantial
funds would be needed to tide the business over the
period of seeking a successor. A small business,
worth $35,000 as a going concern and with equip-
ment alone worth that amount, without regard to
goodwill, might understandably have to be sold for
much less unless there were ample time to search
for a successor.
Many small businesses, built around some
unique contribution or specialty of the proprietor,
could conceivably find no buyer whatsoever. Its
income-producing value would vanish overnight.
THE SOLUTION: ADVANCE PLANNING
To meet these problems, the proprietor needs to set
up a well planned working program for taking care
of the business and the heirs at death. This plan
should include:
1. A will covering disposition of his business.
2. A purchase and sale agreement or carefully
drawn plan for disposal or continuation of the
business.
3. An estimate of the funds required to carry out
the details of the plan.
Inasmuch as a will, a trust agreement, possibly
a purchase and sale agreement and a life insurance
program are to be written, it is evident that
consultation between the insurance agent, the
accountants, the trust officer and the attorney of
the proprietor is advisable. These experts can
determine what is needed and draw up a plan to
meet the legal technicalities and financial needs
involved.
The details of the plan will not necessarily
follow any set pattern. For example, business life
insurance for a sole proprietorship, even more than
for any other type of business, must be tailored to
the particular case.
What the plan will involve, what kind of
insurance is suitable, how it will be set up, depends
on several factors. Some of them are:
1. Type of business.
2. Time urgency.
3. Disposition of the business.
4. Funds available.
5. Probable needs in the period following death of
the owner.
Where it is determined that the funds available,
including existing personal life insurance, are
insufficient to meet the needs as determined,
business life insurance for sole proprietorships is
now widely in use. A suitable business insurance
program can produce the following results.
1. Assure immediate funds to meet taxes, debts
and administrative expenses.
2. Provide income for the heirs.
3. Equitably distribute the property value to the
heirs.
4. Enable the trustee to dispose of the business to
best advantage, if the family is not taking it
over.
5. Put the family on sound financial footing, if it is
assuming direction of the business.
6. Stabilize the credit of the business.
7. Maintain good employee relations by elimin-
ating uncertainties and hazards.
OTHER INSURANCE NEEDS
The sole proprietorship, like all other businesses,
may have need for other types of business life
insurance. In some cases, the proprietor may have
a key employee upon whom a share of the success
of the business depends.
For example, a grocer may have a meat
department under a butcher whose personal trade
is quite an asset for the business as a whole. Death
of such a key man could be a heavy blow to the
whole business.
The owner of a small paper may be similarly
situated with respect to an editor. A small manu-
facturer may have an inventor, chemist, engineer,
or other expert whose death would prove costly.
Key-man life insurance gives the proprietor cash
as a cushion against this type of loss.
The sole proprietor may also have the same
needs as his partnership or corporate competitors
in the area of supplementary insurance protection.
That is, his needs may be the same for group life
insurance, group annuities or pensions, group
hospitalization, surgical and medical insurance,
group major medical, and group disability income
insurance.
If his employees are sufficiently numerous, he
can provide these coverages through group insur-
ance. If his employees are few, he can set up
equivalent but more expensive plans through group--
written individual policies.
Interest in these supplementary plans among
owners of very small business units has increased
materially in recent years and probably will continue
to do so in the years ahead. Competition for good
workers will be a factor, as more and more of the
larger concerns provide these types of protection
for their workers.
PERIODIC CHECKUP
Sole proprietorship life insurance is so definitely
and closely linked with the whole program of
personal insurance and personal finances of the
proprietor that it should be frequently checked.
Such a check helps the owner-manager to make
certain it is in keeping with the requirements of the
personal-business relationships at all times.
This check should be made at least once a year.
It is even more important than the annual inventory
of stock, in that it involves future equities and
income from the business far into the future.
It is not enough to set up such a plan and then
file away the papers unseen for a period of years.
The plan, left unchecked, might prove not only
inadequate, but actually a handicap to proper
handling of affairs at the proprietor's death.