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Life insurance to protect entrepreneurs



Life insurance for buy-sell agreements

What is a buy-sell agreement?

A buy-sell agreement is a written legal agreement that describes the plans for how a deceased entrepreneur’s interest in the business will be sold to a buyer. The sales price is predetermined and documented in the agreement.

There are three parties involved in a purchase and sale agreement. You have the business owner, person or entity who agrees to buy the owner’s share in the business (this is often a co-owner) and the business owner’s heirs.

A buy-sell is necessary to protect your business and your family should you die unexpectedly. Without a plan, what happens to your stake in the company?

If you are the sole owner, this means that your company basically ceases to operate without proper planning. If you are in a partnership, this means that without proper planning, your share of the business goes to your heirs who may not have an interest in the business or may not be best suited to take over.

The goals of those involved

The surviving entrepreneurs want to be able to continue running the business without interruption or interference from the deceased owner̵

7;s heirs. They do not want any third party to come in and take over the business they have been engaged in for many years.

Surviving entrepreneurs also want to be able to buy the deceased owner’s share of the business quickly and at a reasonable price. They also want to maintain the loyalty and support of all employees, customers and creditors during this difficult time.

The heirs of the deceased owner want continued financial security after the loss of their next of kin. They either want to keep their rightful share of the business or get a reasonable price for their business interests. And they want a quick settlement of their loved one’s estate.

Entrepreneurs want to ensure that their business and family are taken care of should they die unexpectedly. They do not want any conflict or legal dispute to arise between the surviving entrepreneurs and their loved ones.

A buy-sell agreement can help:

  • Increase a company’s ability to prosper after major life events;
  • Maintain ownership control;
  • Provide continuity in management;
  • Convert unsaleable shares to cash;
  • Establish a fair and reasonable price for the business;
  • Help determine the value of the deceased’s interest in federal property taxes.

Types of buy-sell agreements

There are three main types of buying and selling agreements:

  1. One-way buy-sell agreements
  2. Cross-purchase buy-sell agreement
  3. Entity-Purchase Buy-Sell agreement

One-way buy-sell agreements

A one-way buy-sell agreement arises when there is a sole owner of a company. There are no co-owners to naturally take over if the owner dies.

Many sole proprietorships do not survive their owners due to lack of succession planning. A one-way buy-sell agreement can help ensure the company’s future success.

How does a one-way buy-sell agreement work?

In a one-way buy-sell agreement, the sole owner undertakes to sell, and the buyer undertakes to buy the business interest if a specific event occurs. This event is usually the death of the owner. The buyer is preferably one of the company’s employees.

The purchase price is predetermined and defined in the agreement. The price is determined either by a fixed price, which should be re-evaluated from time to time, or a formula specified in the agreement. The buyer buys a life insurance on the entrepreneur’s life for an amount corresponding to the purchase price. Upon the entrepreneur’s death, the buyer buys the owner’s share of the estate.

If the entrepreneur ever wants to sell the company during his lifetime, the buyer specified in the purchase and sale agreement has a “pre-emptive right”. This means that the business owner must first offer to sell the company to the named buyer before attempting to sell it to a third party. Only after the named buyer has declined the offer can the owner carry out a third-party sale.

Cross-purchase buy-sell agreement

A cross-purchase buy-sell agreement is an agreement between business owners where all owners undertake to buy another owner’s business interest if a certain event occurs, usually death. This type of buy-sell works well for companies with two to three owners who are all relatively close in age.

How does a cross-purchase buy-sell agreement work?

With a cross-purchase buy-sell agreement, each business owner agrees to buy part of a deceased owner’s business interest. To finance this, each owner buys a life insurance policy for every other owner’s life. The total coverage amount for each insurance should correspond to the total purchase price for that owner’s share of the business.

Example of a cross-buy buy-sell

John, Sue and Joe own equal shares in a company valued at $ 3,000,000. Therefore, each of their shares is worth $ 1,000,000.

John buys a $ 500,000 life insurance policy on Sue and a $ 500,000 life insurance policy on Joe.

Sue buys a $ 500,000 life insurance policy on John and a $ 500,000 life insurance policy on Joe.

Joe buys a $ 500,000 life insurance policy on John and a $ 500,000 life insurance policy on Sue.

Each owner is insured with a total of $ 1,000,000, their share of the business. If an owner dies, each of the surviving owners uses the $ 500,000 death benefit to purchase the total share of $ 1,000,000 from the deceased owner’s estate.

It is advisable to use cross-purchase agreements when the owners are relatively old. This is because the life insurance premiums that insure a young person are very different than they would be on an older person. It would not be fair if a 35-year-old co-owner paid insurance premiums on a 65-year-old co-owner.

In addition, a cross-purchase agreement is best if there are only a few owners involved. With the example above, there are six total life insurances for three owners. What if the company had six owners. Then there would be a total of 30 life insurances because each owner must own an insurance on every other owner. This can be quite complicated and a lot to deal with.

For companies that have a big difference between the ages of owners or several owners, a buy and sell agreement would be best.

Entity-Purchase Buy-Sell agreement

A buy-sell agreement for companies is ideal if there are many entrepreneurs or if the owners’ ages are very different.

How does an entity buy-sell agreement work?

With a unit-buy buy-sell, the business unit agrees to buy a deceased owner’s share from the deceased owner’s estate at a predetermined price.

The company needs each owner’s consent to purchase life insurance for their life. The insurance coverage should correspond to the purchase price for that owner’s share of the business.

The business also has access to the insurance’s cash values ​​in a buy-sell agreement for companies. Usually this is not allowed with cross-purchases and one-way purchases.

Financing of buy-sell with life insurance

A buy-sell agreement must be financed to work. Life insurance is often the most effective way to finance these sales.

What type of life insurance should be used?

There is no general answer to what type of life insurance is best in a buy-sell scenario. It depends on several factors in the business planning situation.

Life insurance may be more appropriate if:

  • The purchase and sale agreement is expected to expire at age 65 or 70.
  • Low annual premiums during the first years are important.

Permanent life insurance may be more appropriate if:

  • Buy-sell requires funds for disability or pension scenarios.
  • The insurance is needed as a source of liquidity or security for the business.

Benefits of using life insurance to finance a buy-sell:

  • Life insurance creates a lump sum of cash to finance the buy-sell agreement in the event of death;
  • Life insurance revenues are usually paid out quickly after your death, ensuring that the buy-sell transaction can be settled quickly;
  • Life insurance income is usually income tax free;
  • If sufficient cash values ​​have been built up within the insurances, the funds can be used to buy an owner’s interest after retirement or disability.

Benefits for insurance holders:

  • Cash becomes available upon the death of the business owner to help meet purchase obligations created by the buy-sell agreement.
  • Assures an esteemed key employee or family member that their loyalty and commitment are recognized and that their role in the business will continue.
  • Access to insurance cash values, if any, to use if the purchase of an owner’s interest occurs before death.

Benefits for the insured:

  • Cash is available for real estate liquidity or other family needs.
  • The resigning owner and his or her heirs are released from business liability.

Purchase and sale agreements are extremely important so it is smart to hire an experienced lawyer to prepare these contracts to ensure that everything is structured correctly.


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