By Rhona Sacks
No gain is so certain as that which proceeds from the economical use of what you already have. —Latin proverb
Your successful water treatment company is more than just your most valuable capital asset—it represents the realization of your dream. During the start-up 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 advisors) leave too much cash behind because they fail to recognize the enormous value hidden within one of their most overlooked and underutilized business assets.
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 for maximum value. Deloitte & Touche recently reported that, “71 percent of small and mid-sized enterprise owners plan to exit their businesses within the next 10 years.”1 Because only 30 percent of family businesses survive to the second generation and just 15 percent survive to the third2, most companies are sold and if a sale isn’t possible, closed. With so many companies up for sale at the same time, the increasing competition to sell demands 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. Traditionally considered inflexible assets with little liquidity, business life contracts have long been viewed as necessary yet unrecoverable expenses. For example:
- Policies funding buy/sell agreements
- Key-person policies
- Split-dollar policies
- Policies securing business loans
- Policies funding retirement and employee benefit plans
- Estate liquidity and equalization policies
Although these business life policies provide valuable services, when putting your company up for sale, some of these life contracts may become obsolete because the original reasons for which they were purchased are no longer relevant. In effect, these policies have outlived their usefulness. Furthermore, after your company is sold, there may be even more business life policies you no longer need to keep in force due to the original objectives becoming outdated.
Historically, exiting entrepreneurs faced limited disposition options when their changing needs rendered their business life 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.
But an innovative asset optimization technique—a life settlement—can convert the hidden value in qualified business life insurance contracts into 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 platform for the life settlement industry was created in 1911 by virtue of Grigsby v. Russell3. In this seminal case, the US 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 no-longer-needed term or cash value business life policies are sold for the highest quality institutional offer, you receive a lump-sum cash payment which can be used 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 69, 71 and 72, were the principals of a successful water treatment dealership. 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 advisors were all 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 paid for many years, these three wise men sold their policies to institutional investors and received unexpected cash windfalls.
By coordinating the sale of their company with the sale of their obsolete buy/sell business policies in the secondary life insurance market for approximately $600,000 each, these owners were able to quickly sell their company at a reduced all-cash price because the life settlement proceeds provided the extra money needed to fill the gap between the selling price and the buying offer.
Life settlement basics
Although life settlement viability is determined on a case-by-case basis, 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, the issuing insurer is an A-rated company and the policy is 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.
Large portfolios of life policies are purchased by institutional investors seeking predictable non-market correlated returns based on the future value of policy proceeds. A funder purchases qualified life policies on behalf of these institutional investors (such as banks, hedge funds, pensions funds, etc.) whereas a broker fields qualified life policies to multiple funders to create a competitive market. Last year, corporate money managers invested $10-15 billion in life settlements4, which was 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 were only permitted to 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 re-purchase price, policyholders traditionally received little economic value from their superfluous life contracts, on average just four percent of the policy’s face value5.
Fortunately, the life settlement industry has replaced this monopsony (an anti-competitive market situation in which a seller is only permitted to sell to one buyer) with a free-market alternative wherein funders competitively bid to acquire the rights and obligations in your dispensable business life 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 20-25 percent of the face value6, a life settlement can be an effective tool for liberating substantial liquidity hidden within a dormant business asset.
Although selling your obsolete business life 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 specialized knowledge of and services responsive to the unique needs of retiring entrepreneurs in the process of selling their companies.
Working with a truly independent advisor who has expertise in both life settlements as well as exit planning is the key to securing the highest quality institutional offer, safeguarding your privacy and making the process of coordinating the sale of your unnecessary business life policies with the sale of your company as hassle-free and efficient as possible.
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 in the secondary life insurance market can be the answer to easily getting your deal done.
- 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, June 2007 and Life Settlement Solutions, June 2007
About the author
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,” call (650) 581-1596 or visit www.legallifesettlements.com