Insuring the Survival of Your Family Business

By Richard A. McGrath, CIC, LIA
Massachusetts Family Business

Your business may be successful today, but will it succeed you?

Most businesses don’t last past the first generation. Fewer than a third of family businesses survive into the second generation, only 12% survive into the third generation and a mere 3% make it to the fourth generation, according to the Family Firm Institute (FFI).

That statistic may not be alarming if you consider that some businesses are created with the idea that they will be sold or will go public, while many very small businesses are designed to last only until the owner retires.

Yet there is a huge gap between the number of business owners who want their children to succeed them and the number that actually do. In a survey of family business owners, Barclays and The Economist found that two thirds wanted their children to succeed them.

Compare the statistics for those that make it to a second generation with those that want to and you’ll see that half of the business owners who want their children to run their business fail – and the numbers only get smaller from one generation to the next.

There are many well-run, well-known family businesses that manage to keep it all in the family, generation after generation, but not every business can be a Wal-Mart, Ford Motor Company or Zildjian Cymbal, the world’s oldest family business, which was founded in 1623.

Sometimes a business dies of natural causes. The owner decides to shut it down because there is no one in the next generation interested in running it. Maybe the business has become outdated or overregulated. Maybe the next generation lacks the ability or the commitment to make it work.

Often, though, the death of a family business is tragic, because it is either unnecessary or contrary to the owner’s intentions. The owner or owners may not have planned for succession or they may have planned inadequately. They also may have been affected by a major lawsuit or by one of the three “Ds” – death, disability or divorce of an owner.

Keeping the Business Alive

What makes multi-generational family businesses different? How does a mom-and-pop business transform into a mom, pop, children and grandchildren business? What can be done to improve the odds of survival?

The toughest part, of course, is the transition that takes place right after the death, disability or retirement of an owner. Divorce, a lawsuit, a natural disaster or other major incident could likewise cause a disruption in business.

In any of these cases, a large sum of money is needed just to keep the business operating. A business may be worth a great deal of money, but it lacks liquidity. The need for cash may make it necessary to sell the business, perhaps at a discount to its actual value.

That’s where insurance can help. Every business is different and there is no single insurance policy that can protect a business against every risk. Disability insurance, directors and officers liability insurance, employment practices liability insurance and other forms of insurance can help to mitigate day-to-day business risks.

But the insurance that will play the most important role in perpetuating a business from one generation to another is cash-value life insurance.

Consider that life insurance can create a “death benefit” worth millions of dollars when an owner dies. If the insurance is owned by a trust, the death benefit will not be subject to estate or income taxes. Funds generated in this manner can be used to address many different issues. For example:

Rewarding all children equally. Business owners need to accept that they will not be running their business forever and need to plan for the next generation. Doing so can be complex, as parents need to be honest and objective about the skills, ambitions and work ethic of their offspring.

What happens, for example, if the owner has two children and one remains in the business as the successor-in-training, while the other takes a different career path? Do you leave the entire company to the child who will run the business? If so, how do you treat the other equally loved child, who is also an heir?

Add more children or, worse still, more marriages and planning for your family can become as difficult as running a Fortune 500 company.

The death benefit from a life insurance policy can ensure that cash is available for children who will not receive an ownership interest in the business.

Paying estate taxes. Up to $5 million in assets can now be exempted from the federal estate tax and a marital trust can be used to double that amount to $10 million. Assets worth more than the exemption are subject to a tax of up to 35%.

Business owners who don’t expect their assets to be worth more than $10 million when they die still have to worry about state taxes. In Massachusetts, which has a top rate of 16%, the exemption is only $1 million. In addition, the federal exemption could change in a couple of years, for better or worse, when current legislation expires.

Life insurance owned by a trust can provide the cash needed to pay not only estate taxes, but any other tax bills and anticipated expenses.

Buying Out an Owner. Many businesses, of course, have more than one owner. Owners may be partners from different families or they may be from the same family.

When one owner leaves the business, whether because of retirement, disability, death or some other reason, the other owners need a mechanism to purchase that owner’s share of the business.

A buy-sell agreement is typically used to ensure that surviving shareholders have the first right to purchase the stock of the former owner and to provide the former owner, or his or her beneficiaries, with a fair market price for the ownership interest. Life insurance is typically used to fund the agreement. If the departing owner is still alive, the cash value, rather than the death benefit, can be used to purchase the ownership interest.

Because it has cash value, life insurance can be used for practically any business emergency. These are just a few examples.

Before taking action, be sure to consult with your business advisors, including your insurance representative, your attorney and your accountant.

Richard A. McGrath, CIC, LIA is President and CEO of McGrath Insurance Group, Inc. of Sturbridge, Mass. He can be reached at

This article is written for informational purposes only and should not be construed as providing legal advice.