The following are concepts we help our clients apply to handle business risks and benefit from those advantages that only business owners have:

Buy/Sell Agreement

A Buy/Sell Agreement is a contractual agreement that provides for the continuation of a business in the event of the death or disability of a sole proprietor, partner or shareholder. An agreement may stipulate that, upon the death of a shareholder or partner of a company, the company or other partners buy back the deceased’s interest in the business. Life insurance is commonly used to fund buy/sell agreements because it provides both liquidity and tax advantages in funding the transaction.

The following are important reasons to use a funded buy/sell agreement:

• Liquidity – A funded buy/sell agreement creates a market instantly for the deceased’s share of the business. Otherwise, if a funded buy/sell agreement were not in place, the purchase of the deceased’s stake in the business would have to come out of the company’s working capital (if there was enough to fund the purchase). In addition, if an outside party were to purchase the deceased’s share, the timing of the transaction could result in a lower valuation of the company because of the death of a key owner and the fact that the deceased’s family wants to sell in a potentially soft market.
• Transition of Business – A funded buy/sell agreement assists in the efficient preservation and transition of the control and management of the business.
• Estate Planning – A funded buy/sell agreement can provide cash for potential estate taxes and settlement costs and establish a valuation of the deceased’s business interest for estate tax purposes.
• Cost – a funded buy/sell agreement funded with life insurance can be inexpensive (the cost for the purchase of a business is essentially the premiums paid for the life insurance policy).

Life insurance provides a simple way to administer a funding vehicle for the purchase of the deceased’s ownership according to the terms of the buy/sell agreement. The business also protects itself from any future drain on working capital, damage to its credit position and/or the legal or financial problems that could arise out of the company’s inability to fund the buy/sell agreement with its own income.

Buy/sell agreements may be set up in conjunction with Sole Proprietorships, Partnerships and Corporations. The method for each is a little different. Below you will find a general description of the options available for each type of business.

How a Buy/Sell Agreement funded by Life Insurance works

Sole Proprietorship

If a sole proprietor has a key employee that has the desire to purchase the business in the event of the sole proprietors death, a buy/sell agreement can facilitate the key employee’s purchase of the deceased’s business. The sole proprietor and the key employee would enter into a buy/sell agreement, and the key employee would purchase a life insurance policy on the life of the sole proprietor. Pursuant to the buy/sell agreement, upon the death of the sole proprietor, the key employee uses the death benefit to purchase the sole proprietors business from his estate.

Partnership

Cross-Purchase Method

The Cross Purchase Method of entering into a buy/sell agreement works best if there are a small group of partners (preferably two). The partners enter into a buy/sell agreement and each partner buys a life insurance policy on each of the other partners lives. Pursuant to the agreement, upon the death of one of the partners, the surviving partners use the death benefit from the above- mentioned policies to buy the deceased partner’s business interest from his or her estate. The surviving partners then own all of the partnership while the deceased partners estate receives the funds from the sale of the deceased partners share of the partnership.

Entity Method

The Entity Method of entering into a buy/sell agreement offers the advantage of simplicity over the Cross-Purchase Method if there are more than two partners or if there is a likelihood of more partners joining the business later. In this scenario, the partnership and each partner enter into a buy/sell agreement. The partnership buys a life insurance policy on each of the partners lives. Pursuant to the buy/sell agreement, upon the death of one of the partners, the partnership uses the death benefit from the above-mentioned policy to purchase the deceased partners business interest from his or her estate. The surviving partners then own all of the partnership while the deceased partners estate receives the funds from the sale of the deceased partners share of the partnership.

Corporation

Cross-Purchase Method

The Cross-Purchase Method of entering into a buy/sell agreement works best if there are a small group of shareholders (preferably two). The shareholders enter into a buy/sell agreement and each shareholder buys a life insurance policy on each of the other shareholders lives. Pursuant to the buy/sell agreement, upon the death of one of the shareholders, the surviving shareholders use the death benefit from the above-mentioned policies to buy the deceased shareholders business interest from his or her estate. The surviving shareholders will own all of the outstanding corporate stock while the deceased shareholders estate receives the funds from the sale of the deceased shareholders stocks.

Stock Redemption Method

The Stock Redemption Method of entering into a buy/sell agreement offers the advantage of simplicity over the Cross-Purchase Method if the corporation has more than two shareholders or if there is likelihood that additional shareholders will join the business later. In this scenario, the corporation and each shareholder enter into a buy/sell agreement, and the corporation buys a life insurance policy on each of the shareholders lives. Pursuant to the buy/sell agreement, upon the death of one of the shareholders, the corporation uses the death benefit from the above- mentioned policy to purchase the deceased shareholders business interest from his or her estate. The surviving shareholders then own all the outstanding corporate stock while the deceased shareholders estate receives the funds from the sale of the deceased shareholders stock.

Key Person Life Insurance

Maybe your business is operated primarily by one person or maybe your company is run by a small team of executives whose expertise is the lifeline of your business. The premature death of a key person could signal the premature death of the business. With a Key Person Life Insurance Policy, a business can increase the chances of survival if it were to lose a key member of the organization.  Funds from such a policy could:

• cover business debt
• leave working capital for a surviving partner(s) to continue the business
• identify and hire a replacement for the key person
• provide cash for the business in case there is a major revenue shortfall because of the loss of the key person

Key Person Life Mechanics

The first factor to consider in setting up a Keyperson Life Insurance Policy is to determine how much death benefit is needed. The minimum usually considered is one times the key persons annual income, but other factors need to be considered. What if the business relationships of this person drive half of the company’s revenues? How difficult and costly will finding a replacement be? Are there business debts that would place financial hardship on the company? Once the death benefit amount has been determined, the business would purchase the policy on the key person. The key person would be the insured and the business would be the owner, payer and beneficiary of the policy. Permanent or term life insurance can be used as a key person policy depending on the needs of the business and how much they are willing to spend.

Executive Benefits

Many variations exist to offer key employees an executive benefit in the form of a life insurance policy owned by the company. Such policies are typically a permanent form of insurance and offer the employer “golden handcuffs” to attract and retain key employees.

Not all business owners know on their own about the advantages that these concepts represent, but the truth of the matter is that all of these concepts provide very high benefits for those involved, we always guide our clients to make sure they achieve their financial goals and determine the correct concept to apply to each individual business plan.