As a partner in a growing business, having a buy-sell agreement in place is a top priority in case you or your partner should pass away.
As an exit strategy, it not only protects your business from uncertainty on how to carry on after the death of an essential company member, but it sets guidelines for handling of left behind ownership shares. These types of agreements are also useful in setting out future support and rights of the decedent’s family if desired, but funding them can be confusing. Many organizations rely on different types of life insurance to fund this safeguard for company continuity when a partner dies. From term life policies to keyman insurance, there are several avenues to follow to create a buy-sell agreement that meets your business needs.
Consider these four areas of funding a buy-sell agreement so that your partnered business can smoothly transition if something happens to you or your partners during your company’s lifetime.
Create a Buy-Sell Agreement that Matches Your Worth
It is vital that your buy-sell agreement uses a valuation that accurately represents your ownership share. Doing this helps to minimize the risk of conflict in the long-term if a business partner or beneficiary wants to receive more shares than they are worth. It also means to update this determination over time to keep an accurate track of business growth in value for future estate and financial planning.
Determine the Best Buy-Sell Agreement Structure for Your Business
There are many structural forms of buy-sell agreements, but the most popular comes down to two specific styles:
- Stock-Redemption plans that require the business to purchase or redeem the departed partner’s interests in ownership.
- Cross-Purchase plans require the surviving company owners to purchase a predetermined percentage of the now removed partner’s interest.
It is also an option to construct a combination of the previously mentioned forms of buy-sell agreements. This hybrid will also determine the right of first refusal between the company and its owners, giving significant flexibility to dispose of shares through selling and purchasing to keep the interest with its original partners.
Fund Your Buy-Sell Agreement Ahead of Time and Adequately
Future planning of how to fund a buy-sell agreement is probably one of the most critical aspects of the creation process. While many businesses prefer to rely on life insurance policies to accomplish this because of cost and tax savings, other ways to finance these agreements include: Sinking fund, cash, loans, and installment plan. If you decide to follow the more economical avenue by utilizing life insurance contracts, there are different ways to do this, depending on the structure you chose.
Stock-redemption agreements would have the company buy life insurance policies for each owner. The entity would also cover all the premiums and is the beneficiary in case of death. This method is also free of income tax, which leaves the death benefit to purchase the decedent’s shares.
Cross-purchase buy-sell agreements require all owners to buy life insurance contracts on each other and would act as the beneficiary of these purchased policies. When an owner passes away, those surviving can buy the remaining shares with the death benefit payout.
Funding Options Using Life Insurance
Determining the type of life insurance to use for funding of your buy-sell agreement involves choosing between several options, which have their own specific benefits. Read on to learn more about popular coverage options businesses rely on to finance their buy-sell contracts.
Short-Term Life Insurance
Some companies opt for temporary coverage like a term-based contract that only lasts for a limited period and brings no cash value. This option may seem appealing because premiums may not be as costly compared to similar permanent life coverage.
Permanent Life Insurance
For business partners considering permanent life insurance, they enjoy lifetime coverage and accumulated cash value over time. This contract type allows for full or partial funding of a buy-sell agreement in the event one of the owners dies. Further, it could transfer with you upon retiring, allowing you to name a different beneficiary, access the value of the policy as additional income, or even start another business venture.
Key Man Insurance
Keyman insurance involves a business entity taking out coverage on employees, paying the premiums for the policy, and is the beneficiary on the contract. If the covered worker passes away, the company receives the death benefit.
This insurance can safeguard a business against an insured being unable to perform their duties for lengthy periods. Profits receive protection under these contracts as any lost sales and revenue, as well as delayed or canceled projects from the insured’s absence, are insurable losses. Antanavage Farbiarz, PLLC can help you. Call (610)-562-2000 or email us to get started!