How to Use an Insurance Policy as a Cash Infusion for Your Business

“From my very first day as an entrepreneur, I've felt the only mission worth pursuing in business is to make people's lives better.” —Richard Branson

I love business. There’s nothing better than being part of an idea coming to fruition through strategy, marketing, teamwork, and a collective drive to make a difference. It’s a rush. Our modern society of constant evolution and change presents both incredible opportunities and major disruption of the old ways of doing things.

If you’re a business owner or thinking of becoming a business owner, this article addresses ways to incorporate more effective structure in how you capitalize your business, incentivize your team, and ensure the proper distance between your personal finances and those of your business.

A Capital Injection from an Unlikely Source

A new or existing business can be capitalized in many ways. Using a policy loan is just one approach, but the flexibility of payback and ease of borrowing makes it one of the best ways to add capital to a company.

Entrepreneur, college professor, and author Mike Moyer wrote a book called Slicing Pie: Fund Your Company Without Funds, which describes how to use capital injection to contribute money to a new or existing business.

Capital injection can be in the form of cash, either as an equity or capital contribution, or as a loan to the business. If you make a capital contribution, now you have money in the bank account and you're meeting payroll and overhead.

Newer companies often lose money in the start-up phase and require this type of ongoing capital support. The question becomes, when do you start getting that money back?

Most business owners don't have a uniform answer for that. They end up taking the money in a random and uncalculated way, which often puts a constraint on the business’s finances.

When there are multiple partners involved, the situation becomes even more complicated and disjointed. Who gets how much? When? How do you decide? Moyer explains some good solutions to this, using what he calls dynamic equity splitting.

Additionally, you can circumvent the dilemma altogether by personally lending money to the business. It’s what I typically do with my business interests and what we teach our business owner clients to do.

Here’s how it works:

1. You request a loan from your insurance company and deposit the funds into your personal bank account.
2. You then make a formal loan to the company in question, documented by a promissory note and amortization schedule. These are recorded on the business balance sheet and in your corporate minutes.
3. The loan has a specified interest rate, one that is comparable to the terms of outside financing by a bank.
4. The terms of the loan can vary. Common arrangements are a fully amortized payback, or a line of credit, where the repayment is of interest only. A rule of thumb is to model your loan after the terms and interest rate a traditional bank would give you.

Once the company starts making money and turns a profit, the next goal is typically to pay off debts. That means paying off the loan you made to the company. If you made a capital contribution instead, that shows up as company equity and the sense of urgency when it comes to repaying a capital contribution isn’t equal.

Capitalizing your business this way aligns with the business practice called Economic Value Added (EVA). EVA is used by companies such as Coca-Cola, Best Buy, Mary Kay, and Whole Foods to assess the cost of capital associated with new ventures. The measurement accounts for the lost opportunity cost of the money used to provide capital to a new location or venture.

Whole Foods states that, “EVA is a guiding philosophy for investing the company’s resources.”  It states that its cost of capital is 8 percent and each new location has the goal of achieving profitability beyond this 8 percent measurement within five years.

Most business owners aren’t at the Whole Foods level, and an 8 percent benchmark may not be suitable for your respective business. But modeling their business practice of valuing the cost of capital is a wise method to ensure your own success and the success of the business.

How to Mitigate Your Opportunity Costs

In my experience, business owners tend to keep a lot of cash in their business. That’s understandable. However, a lot of cash could be a risky proposition from a liability standpoint.

If your business is ever sued, that money can be in jeopardy.

Additionally, keeping that cash in a bank triggers a large opportunity cost. Business bank accounts pay similar returns as personal bank accounts.

To avoid carrying too much cash, you can use an established Wealth Maximization Account to carve out profits from your capital account. The profits can be held outside of the business in a creditor-protected private asset. It becomes your personal savings, your liquid wealth, and provides an ideal separation of your personal assets and business assets.

Most business structures are taxed as pass-through entities—either a partnership or an S corporation. This means that the profits are taxed at the personal income tax level. From a tax perspective, it doesn’t matter whether you keep the money in the business or take a personal distribution—you are taxed equally.

The following side-by-side comparison shows how large that opportunity cost can be over time.

Assumptions for a business savings account:

• Annual business cash flow: $100,000
• Business savings account APY: 0.5 percent
• Marginal tax bracket: 33 percent
• Years to analyze: 20

Results:

• Total contributions: $2,000,000
• Interest earned: $71,865
• Taxes Paid: $35,396
• Ending balance: $2,071,865

Assumptions for an established  Wealth Maximization Account:

• Annual business cash flow: $100,000
• Interest and dividend paid on cash value: 5 percent
• Years to analyze: 20

Results:

• Total contributions: $2,000,000
• Interest earned: $1,471,925
• Taxes Paid: $0
• Ending balance: $3,471,925

A business saving $100,000 at a traditional bank over the course of 20 years equates to more than $1.4 million in opportunity cost.

I keep a few months of cash reserve in my business, but I keep everything else inside multiple WMAs. That way, if my business ever needs money—for, say, a marketing campaign, software, a new employee, or a new venture—I can use the liquidity of a policy loan to provide the capital. Also, the earnings are multiple-times greater than the typical depository account.

By loaning against your insurance policy, you not only mitigate your opportunity costs, but you also give yourself a chance to expand your business, especially when you’re in need of cash flow.