If you’ve spent a lifetime building a family business, you may find that it’s among your most important assets. A carefully developed succession plan can help you engineer a smooth transition into the company’s next phase, whether you plan to sell the business or pass it on to your heirs after you’re gone. The type of life insurance policy you choose can play a key role in that plan. Though the primary role of life insurance is to protect against premature death, it can also be used as a tool to help you divide your estate or provide liquidity to keep your business running after you’re gone.

If you have family members active in the business that you would like to take over when you are gone, a family buy-sell arrangement involving life insurance may be appropriate.

Equality among heirs

Deciding how to divide a family business among heirs can be fraught with challenges. In some cases, each heir may be involved in the business, and the shares can be divided equally. If one or more of your heirs doesn’t want to help run the company, however, including a life insurance policy in your succession plan can help divide your estate fairly.

Say you have three children, two of whom are active in the family business and a third who is not. You want to leave an equal inheritance to all three, but simply dividing the business evenly among them could lead to potential challenges and conflict between the siblings who are active in the business and the sibling who is not.

Life insurance, along with other tools, can provide a way to address this conundrum.

Liquidity for a smooth transition

A family buy-sell arrangement provides a way to pass along a family business to your family members who are active in the business while also providing for a surviving spouse or other heirs who are not active in the business. Under this type of arrangement, there would be a buy-sell agreement between you and your family members who wish to remain active in the business. To fund the buy-sell, the active family members could be the owners and beneficiaries of a life insurance policy on your life.

When you die, your business is included in your estate,* and the death benefit proceeds from the life insurance policy go to the active family members income tax-free.** They can then use these funds to purchase the business from your estate under the terms of the buy-sell agreement. In this way, your business passes only to family members who are active in it, and cash is made available as a result of the purchase of the business from your estate to provide for family members who don’t want to participate in the business.

Also consider a key person life insurance policy to help cover the financial impact of the loss of a key employee. This type of policy, of which the business is the owner and beneficiary, can be especially valuable for businesses that depend heavily on a small number of individuals whose skills or expertise would be difficult to replace. Key person insurance can cover the lost revenue and/or profits the business would experience as result of the loss of the key employee, as well as the cost of recruiting and training a replacement.***

Determining the fate of a family business can be a challenging emotional process. By planning ahead, you may avoid potential conflict and set up your business—and your family—to thrive for generations to come.