Using life insurance to fund a buy-sell agreement is a very common strategy for business owners.
Whether you own a large company or a small family operated business, the success of any business depends on smart strategy and planning. The death of an owner or partner can be an uncertain time for the life of a business.
A buy sell agreement can help protect your business from the effects of unintended or unwelcome transfers of ownership. It may also help protect your heirs by providing an opportunity to turn inherited business shares into cash.
What is a buy-sell agreement?
A buy-sell agreement is the legally binding contract between co-owners of a business that outline steps to be taken in the event that one of the owners dies or otherwise leaves the business.
Think of it like a will for the business. Buy-sell agreements are drafted by an attorney and usually contain legally binding clauses like:
- Who can buy a departing partner or shareholder’s share of the business
- Which event could trigger a buyout? (death, disability, retirement or an owner leaving the company)
- The price to be paid for a partner or shareholder’s interest in the company
By planning ahead and taking legal steps to ensure those plans are intact in the event of a buyout trigger drafting a buy sell agreement among business owners can help to avoid costly legal battles and financial setbacks by the business.
How does life insurance help a buy-sell agreement?
When the buy-sell agreement is created, it legally obligates 1 party to purchase the others interest in the business. But where do surviving owners come up with a large sum of cash to fund the purchase?
Liquidating assets may not be an option for the business, causing owners to put their own personal property up for collateral – which puts them personally at risk.
Life insurance death benefit proceeds however transfer efficiently and tax free (if structured properly). So that cash is available to fund the purchase.
Types of buy-sell agreements
There are several common types of buy sell agreements used:
Cross-Purchase Agreement
Used when two partners own a business together. It begins with co-owners of the business agreeing to transfer shares or business interest in the event of a death or other trigger. The terms (including price) are outlined in the contract and both parties sign the agreement promising to sell their share to the remaining partner or owner of the business. So if something happens to one owner, the surviving owner has rights to the owner’s share of the business… rather than watching that portion of the business pass to the surviving spouse or heirs.
Entity-Purchase Agreement
The business itself agrees to purchase any shares of the business from the deceased owner or shareholder effectively absorbing the shares among surviving owners or shareholders.
One Way Buy-Sell Agreement
This type of agreement is designed for a situation in which a company is owned 100% by one person. In the event of an owner’s death, a one-way buy sell agreement would arrange for the business interest to be purchased by a designated person named in the contract. Often times this is a key employee that would like to take over the business for a predetermined price.
It’s important to protect all the hard work that’s involved in building a business. Rootfin offers life insurance solutions to help insure that all the effort and money invested in the business won’t disappear when the unexpected happens.
Please don’t hesitate to contact us for instant life insurance quotes for a buy-sell agreement. We’ve help dozens of business owners find the lowest cost life insurance to fund their buy-sells and we’d appreciate the opportunity to earn your business.
Important: Life insurance agents do not give legal or tax advice. You’ll need to work with a qualified attorney to draft the buy-sell agreement.