Have you ever heard stories about family businesses ending up in the wrong hands due to a death in the family or an owner choosing to leave the industry? We have. Nothing is worse than being forced to do business with a stranger and having no way out other than an expensive buyout. So how do you avoid that? How do you prepare for changes in the ownership of your business?
With a buy-sell agreement that is funded by life insurance.
A buy-sell agreement is a legally binding contract between multiple owners of a business. You may also hear it referred to as a buyout agreement. This contract lays out the plans for situations where an owner passes away, files bankruptcy, chooses to leave the business, and more. It dictates what happens to that person’s portion of the company.
When you fund a buy-sell agreement with life insurance, the company or individual owners would buy life insurance policies on the lives of each owner. There are two main types of buy-sell agreements to look at when funding by life insurance. They are a cross-purchase plan and an entity purchase or stock redemption plan.
- A cross-purchase plan is where each business owner purchases a life insurance policy from each of the other owners. Then, when an owner passes away, the remaining owners will use the payout from the life insurance policy to purchase the deceased owner’s share of the business.
- An entity purchase or stock redemption plan is where each owner enters into an agreement with the business to sell, the interest in the business. The business will purchase the life insurance policies for each owner and pay the premiums. When an owner passes away, the business then uses the life insurance payout to purchase that owner’s share of the business from the estate or heir, depending on where the share of the business passed to when the owner passed away.
Let us look at an example:
A couple owns a jewelry store. They have two daughters. Both daughters get married and are given their own portion of the business. So now the business is owned by all three couples equally. Unfortunately, the older daughter passes away and her spouse is left with her share of the business. Years later, he remarries. Now the business is owned by the parents and daughter, as well as the widower and his new wife. If he were to pass away, the business would be owned by the parents, daughter, and the new wife.
If the parents and their daughters had a buy-sell agreement, they could have purchased the older daughters’ share of the business from her widower and avoided the situation. If it were funded by life insurance, they would be able to use the life insurance benefits to do so. Otherwise, they would need to hope that the widower or his new wife would be willing to sell their share of the business for a decent price and hope they had the money.
No matter what type of business you are in or who you are in business with, it is a good idea to have a buy-sell agreement. You never know what will happen, and this type of agreement helps to prevent any issues in the future. By funding that agreement with life insurance, you can be sure that in the event of a death, you will have the funding to fulfill the agreement.
When creating your buy-sell agreement, be sure to work with an attorney and CPA to ensure that all parties are aware of their value in the company and agree on the contract. When it comes to funding that agreement with life insurance, contact your independent agent to make sure that you are covered for your needs. Call Gannon Associates Insurance today at 844-GANNONS and let us help you fund your buy-sell agreement today!