Using Life Insurance to Fund a Buy-Sell Agreement

Posted by Mark Osborne on Sep 22, 2016

The term 'buy-sell agreement' often triggers thoughts of complex legal documents reserved for large corporations.

But the reality is, any business that has more than one owner needs to seriously consider putting a buy-sell agreement in place.

Without a buy-sell agreement, your business is really rolling the dice with its future success, and is only one accident, death or disagreement away from being in financial ruins.

It doesn’t have to be complicated, or a long, drawn-out process involving numerous attorneys. But it does take some thought, and it's critical to the future success of the business.

Why?

Because at its core, the buy-sell agreement protects the interests of all owners by dealing with a number of sensitive issues while everyone is calm & collected.  Issues such as:

  • Setting the terms of the agreement
  • Determining a fair value for each owner’s interest
  • Laying out when an owner can sell their interest
  • Defining who can buy an owner’s interest
  • Outlining how the business is transitioned if one of the owners were to pass away

These types of issues can become extremely difficult to address at the time an owner wishes to exit, or upon the death of an owner.

It’s for this reason that so many businesses execute a buy-sell agreement and at the same time, use life insurance to provide the funds to fulfill the obligations of the agreement if an owner were to pass away.

The Basics of a Buy-Sell Agreement

A buy-sell agreement is a contract between business owners which, upon the death of one of the owners, requires the remaining owners, or the company, to purchase the deceased’s interest in the company according to the agreed upon terms of the contract.

In addition, the deceased’s heirs are required to comply by selling their inherited interest at the previously agreed upon price.

This mechanism protects both the family of the deceased, and the remaining owners of the business.

Without payment for their interest in the company, the heirs of the deceased owner may wish to become involved in the day-to-day operations of the business. 

While there are instances when this is a good thing, more often, it creates significant complications for the remaining owners, and drives the value of the organization down.

Although there are other options for funding a buy-sell agreement, one of the most efficient and widely used methods for doing so is through Life Insurance.

Why?

Life Insurance ensures that funds are immediately available when a death occurs.  In addition, death benefit proceeds are generally income-tax free.  And if structured correctly, the funds used to purchase the deceased’s share are purchased for pennies on the dollar, and the premiums will likely be significantly lower than the cost of repaying loan interest.

Types of Buy-Sell Insurance Plans

There are two main types of buy-sell insurance plans:

1. Cross Purchase Plans

Under this type of plan, the owners enter into an agreement with each other.  Each owner purchases a life insurance policy on the other owners, and will be named the beneficiary of the policy.

Upon the death of an owner:

  • Each surviving owner receives life insurance proceeds income-tax free
  • Heirs receive an agreed upon payment for their business interest
  • The surviving owners use the proceeds from the life insurance policy to redeem the deceased owner’s interest in the company

2. Entity Plans

In this type of agreement, also known as a stock redemption plan, the company purchases life insurance policies on each owner, with the company itself being named as the beneficiary.

When an owner dies, the company receives the life insurance proceeds and uses them to purchase the deceased’s business interest, while the heirs receive an agreed upon payment for their business interest.

Curious about the benefits of a buy-sell agreement?

  1. First, it helps establish a valuation of the deceased owner’s interest in the business for estate tax purposes
  2. It also establishes a mutually agreeable price and terms, prior to a tragedy occurring where emotions are already tense and not ideal for negotiating the value of the business
  3. And to the family of the deceased owner, the buy-sell agreement makes sure they receive cash instead of unmarketable stock which could devalue rapidly after the loss of a key employee

Conclusion

Finding the best life insurance policy to fund a buy-sell agreement in Ohio can be confusing, time consuming and difficult.

However, making sure the right insurance protection is in place is absolutely critical to ensuring your business can recover from the loss of an owner.  Without it, the business, and its employees, are one tragedy away from being in serious financial hardship.

And remember, not all policies are created equal.

You probably wouldn’t go to your eye doctor instead of your dentist if you were having a toothache, right?  Just because they’re both doctors doesn’t mean they have the same skillset.

Just the same, you need an Insurance Advisor that understands your individual needs, your business and its goals, and how best to protect them.

We can help.

We know the Life Insurance market, we take the time to listen and understand your needs, and we work with multiple insurance companies so we can deliver the insurance solution that’s perfect for you, and your budget.

When you have confidence in your Insurance Advisor, you have greater peace of mind knowing that your business, your employees, and your family will have the financial resources needed, even when disaster strikes. 

To get started on your customized solution, contact one of our Licensed Advisors, or Request a Proposal and we’ll get to work right away.

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