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Funding a Buy-Sell Agreement With Life Insurance

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Funding a Buy-Sell Agreement With Life Insurance

Written by: Lee Sherman

Starting a business with someone else is exciting. When two people bring their respective skills to the business, the results can be almost magical. But if one partner dies, it can cause extensive damage to your business including a disruption in revenue, a loss of customers and a reduction in company morale. At worse, it could even cause the business to collapse completely. However, there is a remedy that you should consider in the form of a buy-sell agreement that is funded with an insurance plan.

What is a buy-sell agreement?

Simply put, it is an agreement between business owners on buying and selling a business. Buy-sell agreements specify what happens in certain circumstances and you’ll need insurance to make sure you are adequately prepared for them. Of particular concern is what happens when one owner decides to leave the business or, worse becomes deceased. These buy-sell agreements are complex and should never be entered into without consulting an expert or three. At a minimum, you’ll need an attorney experienced in business law and an insurance agent you can trust.

Consider a contingency plan

There are two types of plans to consider: a cross-purchase plan or an entity purchase agreement (sometimes referred to as a stock redemption plan).

Think of the cross-purchase plan as a kind of double indemnity plan in which each business owner takes out a life insurance plan on the other. When one dies, the surviving owner uses the money they receive from the insurance benefit to purchase the deceased owner’s share of the business.

An entity redemption plan is a bit more complicated but works well when there are multiple owners of a company or when the employees are considered owners. In this arrangement, each owner enters into an agreement with the business whereby the business purchases life insurance for each of the owners or employees. There is no limit to the number of employees you can insure. Unlike the cross-purchase plan, the business pays all premiums and is considered the beneficiary. When an owner or employee dies, their share of the company goes to their heirs. The business may use the insurance benefit to buy their share back but this is neither guaranteed nor required. While the idea behind the entity redemption plan is to keep ownership in the family so to speak, this could leave a person with ownership in a company they have no interest in managing.

No business owner wants to think about one of the other owners passing away. But part of starting a business is being prepared for the unexpected. With a buy-sell agreement in place, you can be assured that the business will still survive in something resembling what its founders intended it to be. Whichever type you choose, the primary advantage is that it provides a legally prescribed way to pass along ownership and redistribute business assets should the unthinkable occur.

Lee Sherman is a contributing writer to www.myperfectfinancialadvisor.com, the premier matchmaker between investors and advisors. Lee is an experienced journalist and editor with over 30 years of expertise with a significant history of writing in the personal finance and technology arenas.

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