Funding a Buy-Sell Agreement with Life Insurance
Do you have a plan in place to protect the continuity of your business? What if one of your co-owners were to unexpectedly pass away? Do you want to be running your business with your former partner’s family? This is where a buy-sell agreement can help.
What is a buy-sell agreement?
A buy-sell agreement is a legally binding contract between the owners of the business which usually provides for the sale of an ownership interest upon the happening of certain events such as death, disability or retirement. The objective of a buy-sell agreement is to provide liquidity to the selling owner; establish a fair market value for the ownership interest under different circumstances; prevent the sale of the ownership interest to third parties; and provide for a pre-determined succession of control and management for the business.
Who’s involved in the agreement?
All of the owners of the business enter into this Agreement and negotiate the terms and conditions of the smooth transfer of the ownership interest in the event of death, permanent disability, or retirement. There are numerous ways that a buy-sell agreement can be structured and there are different tax and legal ramifications for each method.
Funding a buy-sell agreement
Life insurance is typically used to fund buy/sell agreements. When using life insurance to fund a buy-sell agreement, either the company or the individual co-owners buy life insurance policies on the lives of each co-owner (but not on themselves). In the case of the death of an owner, the policy owners (the company or co-owners) receive the death benefits from the policies on the deceased owner’s life. That money is then paid in accordance with the terms of the buy-sell agreement to the surviving family members as payment for the owner’s interest in the business.
If all goes well, the family gets a sum of cash they can use to help sustain them after the owner’s death, and the company has ensured its continuity.
Advantages of using life insurance
- Life insurance creates a lump sum of cash to fund the buy-sell agreement at death.
- Life insurance proceeds are usually paid quickly after death, ensuring that the buy-sell transaction can be settled quickly.
- Life insurance proceeds are generally income-tax free.
- If whole life insurance is used to fund the buy-sell agreement, and sufficient cash values have built up within the policies, the funds can be accessed to purchase the business interest following an owner’s retirement/disability.
Jen and Kate’s parents started their fabric business Sew What over 25 years ago. At retirement, Jen and Kate’s parents passed the business to the two sisters, who had worked alongside Mom and Dad since childhood. Jen and Kate want to put some kind of agreement in place to protect the business should something happen to either sister, and to preserve it for their own children.
Here’s where the buy-sell agreement comes in.
First, KLR Wealth advisors worked with the sisters and their attorney to identify their goals for different potential scenarios (disability, death, retirement). Then, KLR advisors must help the sisters determine a current value for the business and a method for valuing it in the future. KLR Insurance Advisors then go out into the marketplace to purchase the best life insurance policies available to fund the buy-sell agreement.
The buy-sell agreement should be fully funded
Without fully-funded buy-sell agreements, closely-held or family businesses face a world of financial and tax problems at an owner’s death, incapacitation, divorce, bankruptcy, sale or retirement. Contact us for more information on how to structure an agreement for your business.
Published on: 10.03.17