The Three Layers of Business Owner Life Insurance
- Layer 1 — Personal income replacement: same as any individual; DIME calculation on personal finances
- Layer 2 — Key person insurance: business-owned policy compensating the business for the owner’s death
- Layer 3 — Buy-sell funding (if partners): insures each partner to fund purchase of the other’s interest at death
Key Person Insurance: Protecting the Business
Key person insurance is owned by the business, with the business as beneficiary. The death benefit compensates the company for: lost revenue during transition, recruitment and training costs for a replacement, business loan repayment, and general stability during leadership transition. Coverage amount typically ranges from 1–5× the key person’s compensation plus estimated business impact.
Business owner earning $150,000 managing a company generating $1,000,000/year in revenue. If their death would cause 6-12 months of business disruption and recruiting a replacement costs $50,000+: key person coverage of $500,000–$1,000,000 is appropriate. This is separate from their personal $2,000,000+ personal coverage need.
Buy-Sell Insurance: Business Succession Planning
A buy-sell agreement sets the terms for what happens to a business partner’s interest at their death, disability, or departure. Life-insurance-funded buy-sell agreements: each partner takes out a policy on the other (or the business buys policies on all partners). When a partner dies, the policy proceeds are used to purchase the deceased’s interest from their estate at a predetermined value.
Buy-sell agreement funding structures
| Buy-Sell Structure | Who Owns the Policy | Death Benefit Goes To | Best For |
|---|---|---|---|
| Cross-purchase | Each partner buys on others | Surviving partner directly | Small partnerships (2–4 partners) |
| Entity purchase | Business buys on all partners | Business | Larger partnerships; simpler administration |
| Wait-and-see | Partners buy, business has option | Flexible at death | Flexible succession planning |
Valuing Your Business for Buy-Sell Purposes
Buy-sell coverage must match business value. Update business valuation regularly (at least every 3 years) to ensure buy-sell policies keep pace with business growth. Methods: multiple of earnings (3–6× EBITDA for most businesses), book value, agreed formula, or independent appraisal. Under-insured buy-sell creates a gap that forces estate liquidation or borrowing to fund the buyout.
Calculate Your Personal Business Owner Coverage Need
Start with personal income replacement — add key person and buy-sell calculations separately.