Can life insurance collateralize business bank debt?

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How banks view lending money to business owners.

Banks follow established rules, which include asking a business owner to collateralize a loan, not just with business assets but also with personally owned assets, such as a principal residence and cottage. Collateralization can require collateralising a spouse’s co-owned assets, even if the business is incorporated.

Add to that a possible collateralization of any assets of a partner or adult child (and their spouses) who also share in ownership. Small business owners can lose their shirts if they default on a loan.

What if an owner dies? It is unwise to assume that a good relationship with the bank will continue if the heir of a small business or a partner is not in favour with the bank manager. Bank managers can change or apply strict policies while reassessing the leniency shown to previous owners or administrators.

Eliminate doubt in a family business, such as a farm, by insuring the oldest owners and succeeding generations using joint-first-to-die policies or individual life insurance policies. In the case of a non-family business, each owner/partner should be insured to cover the company’s debt. When the life insured dies, the tax-free life insurance proceeds can be used to pay back loans, win back ownership, and discharge any personal assets liens.

What if there is a critical illness? For the same reason, small business owners should consider purchasing a critical illness (CI) insurance policy for each principal business owner and key persons. CI insurance could pay off a considerable bank debt if one were to experience a significant illness such as a heart attack or stroke. One could become incapacitated and need to be bought out by a partner or an heir (there should be a buy-sell agreement in place). The risk of a loan being called increases when an owner-manager is sick, and the bank manager loses confidence in the debt-paying influence of that owner.

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