Your successful company is more than just your most valuable capital asset — it represents the realization of your dream. During the startup and growth stages, enhancing your firm's productivity was your primary goal. Now that you've decided to sell your company and retire, your primary goal is to extract maximum value from the business you've worked hard to build. Unfortunately, too many exiting entrepreneurs (as well as their legal, financial and business advisers) leave too much cash behind because they fail to recognize the enormous value hidden within one of their most overlooked and underutilized business assets.
“No gain is so certain as that which proceeds from the economical use of what you already have.”
— Latin Proverb
Increasing Competition to Sell
Due to the aging of the baby boomers, we are at the precipice of the largest business transition in history, with millions of entrepreneurs seeking to monetize business equity. Deloitte & Touche recently reported that “71 percent of small and midsized enterprise owners plan to exit their businesses within the next ten years.”1 Because only 30 percent of family businesses survive to the second generation and just 15 percent survive to the third,2 most owners sell their companies, and if a sale isn't possible, the doors close. With so many companies up for sale at the same time, the increasing competition to sell creates a demand for innovative asset leveraging strategies to capture optimum value as well as create more cash with which to expedite a sale.
Your Hidden Business Assets
Throughout the business cycle, companies purchase numerous business life insurance policies for risk management, employee benefit and investment purposes. Examples include policies funding buy/sell agreements, key-person policies, split-dollar policies, policies securing business loans, policies funding retirement and employee benefit plans, and estate liquidity and equalization policies. Traditionally considered inflexible assets with little liquidity, many regard life insurance policies as necessary yet unrecoverable expenses.
When a company is up for sale, some of these life contracts may become obsolete because the reasons for their purchase are no longer relevant. And with the sale of a company, additional business life insurance policies may outlive their usefulness.
Historically, exiting entrepreneurs faced limited disposition options when their changing needs rendered their business life insurance policies unnecessary: allowing the policy to lapse, thereby forfeiting the value of all premiums paid, or surrendering the policy to the original insurance carrier for its cash surrender value, an amount which doesn't reflect its true value.
Today, there is another option. You can use an innovative asset optimization technique — a life settlement — to convert the hidden value in qualified business life insurance contracts to significant immediate cash, providing a much higher return on your investment.
What Is a Life Settlement?
A life settlement is the sale of a life insurance policy to an institutional investor for a cash payment that is greater than the policy's cash surrender value. The Grisby v. Russell case in 1911 virtually created the platform for the life settlement industry.3 In this seminal case, the U.S. Supreme Court declared insurance policies to be personal property and freely assignable, thereby granting a policyholder the right to transfer ownership to others.
With a life settlement, when your term or cash value business life insurance policies become unnecessary and you sell them for the highest quality institutional offer, you receive a lump-sum cash payment that you can use for any purpose, including facilitating the sale of your company for the desired price and on favorable terms.
An Entrepreneurial Tale
Three business partners, ages 66, 68 and 70, were the principals of a successful wholesale distribution company. To fund a cross-purchase buy/sell agreement, each partner owned two $3,000,000 term policies (no cash surrender value) on the lives of the other partners. Seeking to sell their firm, these entrepreneurs received no offers that they felt were adequate for achieving their retirement and legacy goals. Unfortunately, their legal, financial and business advisers were unaware of the enormous value hidden within these business term policies, believing that they were worthless due to having zero cash redemption value.
Instead of lapsing the policies and receiving no return on the premiums they had paid for many years, these three wise men sold their policies to institutional investors in the secondary life insurance market and received cash windfalls of approximately $600,000 each.
By coordinating the sale of their company with the sale of their obsolete buy/sell policies, the owners were able to sell their company quickly at a reduced all-cash price because the life settlement proceeds provided the money they needed to fill the gap between their original selling price and the offers from buyers.
Life Settlement Basics
Although a case-by-case decision determines life settlement viability, with all transactions subject to relevant legal requirements and underwriting authorization, the general purchasing parameters are: the insured is 65 or older, the policy's death benefit is $250,000 or more, and the policy has been in force at least two years.
Unlike applying for life insurance, no medical exams or extensive interviews are required. The underwriting process involves only paperwork, such as your life insurance policy and in-force ledger as well as your medical records, which are necessary to verify the specifics of your insurance and health. Furthermore, there are no appraisal, application or processing fees.
Institutional investors purchase large portfolios of life policies seeking predictable nonmarket-correlated returns based on the future value of policy proceeds. In 2006, the most recent year that figures are available, corporate money managers invested $10 billion to $15 billion in life settlements4 — more money than in the previous seven years combined — because they are increasingly interested in purchasing pools of life policies to diversify their portfolios into alternative investments.
End of a Monopsony
Imagine a world where you could only sell your house back to the builder, your automobile back to the dealer and your stocks back to the issuing corporation. This is what a world without secondary markets would look like, and this is the world that life insurance policyholders have traditionally encountered.
Before the emergence of the secondary life insurance market in the late 1990s, the originating insurer was the only potential purchaser for your expendable business life insurance contracts, thereby restricting your policy disposition options to receiving an artificially low cash redemption value. Because the insurance companies set the repurchase price, policyholders traditionally received little economic value from their superfluous life contracts, on average just four percent of the policy's face value.5
Fortunately, the life settlement industry has replaced this monopsony (an anti-competitive market situation in which a seller has permission to sell to one buyer) with a free market alternative wherein companies competitively bid to acquire the rights and obligations in your dispensable business life insurance policies. This vibrant marketplace enables you to retrieve the fair market value from these otherwise illiquid business assets. With the average life settlement payout today being 20 per-cent — 25 percent of the face value,6 a life settlement can be an effective tool for liberating substantial liquidity hidden within a dormant business asset.
Although selling your unnecessary business life insurance policies in the secondary life insurance market can be profitable, navigating the labyrinthine life settlement marketplace can be challenging. The nascent life settlement industry, in general, lacks ample due diligence and transparency as well as knowledge of and services responsive to the unique needs of retiring entrepreneurs in the process of selling their companies.
Analyzing the expendability of your business life insurance policies, coordinating the sale of your obsolete policies with the sale of your company, safeguarding your privacy and securing the highest quality institutional offer demand specialized advisory skills in exit planning, business life insurance and life settlements. Working with an independent adviser who has expertise in these disciplines is the key to a successful, efficient transaction.
Get Your Deal Done
Every day, retiring business owners frustrated by inadequate purchasing offers for their firms unknowingly discard valuable capital assets by cash-surrendering and lapsing their no-longer-needed business life policies. Selling these hidden business assets can be the answer to easily getting your deal done.
Rhona Sacks, an attorney and business coach, is the founder and president of Legal Life Settlements, a mergers and acquisitions advisory company specializing in helping retiring business owners extract maximum value from their hidden business assets. Legal Life Settlements is the only firm in the life settlement industry exclusively dedicated to serving the unique needs of exiting entrepreneurs. For more information or to receive a copy of the article, “10 Tips for Optimizing Your Life,” please call 650/581-1596 or visit www.legallifesettlements.com.
- Is Your Business Worth What You Think It Is? Deloitte & Touche LLP — Canada, 2006.
- Small Business Administration, 2003.
- 222 U.S. 149 (1911).
- A.M. Best Company, Inc., 2006.
- “Turn Unneeded Policies Into Cash: A Life Settlement Can Be A Better Alternative Than Surrendering A Policy,” Journal of Accountancy, September 2005, James D. Warring.
- Maple Life Financial, 2007, and Life Settlement Solutions, 2007.
© 2008 Rhona Sacks. All rights reserved.