A buy-sell agreement is an agreement between the owners of a business. The agreement states that the interest of any who passes away will be purchased by the surviving co-owners (or by the business) at a price that is agreed upon and stipulated in the agreement.
Funding a Buy-Sell Agreement with Life Insurance
One of the most popular ways of funding a buy-sell agreement is with life insurance in a cross purchase buy-sell agreement. These agreements state very clearly what would happen in the event that one of the owners dies or becomes disabled. The surviving owners agree to purchase that owner’s interests in the business. For each owner, a life insurance policy is purchased and has a death benefit equal to the current value of each owner’s share of the business. It should be noted that in order to take into account the potential future increase of value, benefits greater than the current business value can be purchased as well.
Buy-Sell agreements can be funded with either permanent (cash-value) or term life insurance. The difference between the two types of policies is that the cash value of a permanent policy can be used for non-death related buyouts. Both types will pay the death benefit, however.
The beneficiary can use the benefit received to pay the estate of the deceased owner an amount that is equal to the value of his or her business interest. In the event that additional life insurance was purchased as key-person insurance, that money could be used by the business to offset any income loss resulting from the owner’s death.
Why Consider a Buy-Sell Agreement?
Private shareholders of businesses often find buy-sell agreements an attractive option because they have a significant financial interest in the company, and surviving family members would be able to conduct a fairly stress-free sale of the business, should that be a possible action. Family members may also even be able to receive a sum of cash to use to help support them after the owner’s death.
Advantages of Funding Buy-Sell Agreements with Life Insurance
Life insurance proceeds are normally paid within a very short amount of time after one’s death, so the buy-sell transaction can be quickly settled. In addition, life insurance proceeds are usually income tax-free, and there are different types of agreements to choose from in addition to the aforementioned cross purchase agreement. In an entity purchase agreement, the business itself buys separate policies on the lives of each co-owner, pays the premiums, and is the owner and beneficiary. A hybrid policy, often also called a “wait and see” policy, allows features from both the cross purchase and the entity purchase models.
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