Buy-Sell Insurance
Why Business Partners Should Consider It
By: Jacob McConnell
The beauty of the competitive market is that inefficiency on the part of one company may present an opportunity for a rival company to exploit. A company that fails to be forward-thinking about potential threats it is facing can very quickly find itself losing market share to other companies more diligent. Due to the intensity of this competitive reality, the business owner is constantly evaluating and reimagining processes of production to give their company the best chance at success.
At its simplest, a buy-sell agreement is a contract that specifies what happens to a partner’s business shares in the event of the partner’s death or decision to leave the company.
While this shifting and tweaking of business processes is a more current endeavor, it is important for a business owner to have a strategy for the future, specifically in the area of business continuity. The approach many business owners turn to is a buy-sell agreement. At its simplest, a buy-sell agreement is a contract that specifies what happens to a partner’s business shares in the event of the partner’s death or decision to leave the company. This kind of agreement often involves life insurance policies to provide the liquidity needed for the purchase of these shares when they become available.
There are two main types of buy-sell structures that utilize life insurance. The first is called a cross-purchase agreement. Under this arrangement, each partner in the business owns and is the beneficiary of a life insurance policy on the lives of the other partners. Were any of the partners to die, each of the surviving partners would receive a death benefit enabling them to purchase the deceased partner’s ownership shares. The result is that the deceased’s shares are redistributed among the remaining partners upon his passing, and the life insurance death benefit provides the tax-free liquidity for the partners to make these purchases.
The second type of buy-sell agreement involving life insurance is called an entity-purchase agreement. With this structure, the business owns a life insurance policy on each of the partners and is the beneficiary of each policy. If one of the partners were to pass away, the business itself would receive a death benefit that it could then use to purchase the decedent’s ownership shares from their estate. Note that even though the business is paying the premiums on the policies, these premiums are typically not tax deductible for the business, so the death benefit can still be received income tax-free.
Regardless of the buy-sell structure that a business has in place, the end result is that it can continue operating as smoothly as possible even in the face of a significant event like the death of one of the partners. Additionally, the deceased partner’s surviving family members will receive money that likely meets a greater immediate need than inheriting ownership shares of a business that they may not know much about.
Though a business owner may find it easy to pay greater attention to more urgent business needs, they cannot overlook the importance of having a proper buy-sell agreement in place.
Though a business owner may find it easy to pay greater attention to more urgent business needs, they cannot overlook the importance of having a proper buy-sell agreement in place. When the unthinkable happens, the existence of a buy-sell agreement allows for the transition process to be smooth for the individuals involved and ultimately promotes the long-term health and success of the business.