Most small business owners invest a great deal in their business. With that in mind, you’ll want to make sure it’s all taken care of if in your absence.
One way to protect your investment and make sure your family is taken care of it the meantime is with a buy-sell agreement.
You can use life and disability insurance to fund your business’s buy-sell agreement. Doing so yields many benefits, and not all of them are specific to the company itself.
What Is A Buy-Sell Agreement?
A buy-sell agreement (also known as a “buy and sell,” a “buyout agreement,” or a “business will”) is an agreement between co-owners of a company. In basic terms, it’s an agreement on what should be done with a co-owner’s share of the company if he or she should pass away or leave the organization.
With this type of agreement, any share of the company held by one of the owners is transferred to the company, thereby making sure business ownership remains within the organization.
Types Of Buy-Sell Agreements
A buy-sell agreement can take a few different forms. There are two basic types, as well as a hybrid option.
The first type of buy-sell is a cross purchase agreement. In this type of agreement, partners or shareholders allow each other to buy their shares should they pass away, retire, or otherwise leave the company.
This is typically done through the use of life insurance plans. Each partner purchases a life insurance policy on each of the others. If one passes away, their life insurance policy kicks in and the funds from it can be used to purchase their share in the company.
An entity redemption plan is centered on the business rather than the co-owners. With this type of agreement, the business itself has made arrangements to purchase each shareholder’s interest in the company.
Again, this is frequently done through life insurance policies, except instead of each individual shareholder purchasing plan on everyone else, the company itself purchases those plans.
A hybrid plan combines elements of the first two.
In the event that one shareholder passes away, their interest is offered to the company. If the company cannot make the purchase (or declines to do so), then the other co-owners make the purchase via the cross-purchase arrangement described above.
Role Of Life & Disability Insurance In Buy-Sell Agreements
When making these arrangements, life and disability insurance can play a key role.
Life insurance policies are frequently used to handle buy-sell agreements of all kinds. If one partner dies, their share in the company generally passes on to their heirs. The agreement enables the company to purchase that interest back, but they need the funds to do so.
A life insurance policy will allow the remaining shareholders or the company itself to obtain the funds necessary to make that purchase, ensuring a company keeps control over its own assets and maintains continuity.
In some cases, a partner in a company may not pass away, but instead, become disabled and unable to contribute to the business. In these cases, disability insurance policies may be used.
There are various types of disability insurance that are applicable in the context of buy-sell agreements, including:
- Disability income insurance, which replaces a disabled person’s income
- Business overhead expense insurance, which covers business expenses for a disabled sole owner
- Disability buy-out insurance, which directly handles the purchase of a disabled person’s share in the company
Disability insurance is frequently neglected in buy-sell agreements, but it can actually be highly important. People are more likely to become disabled than pass away, after all. Including disability insurance policies in your buy-sell agreement will ensure business ownership remains in the company while making sure co-owners and their families are cared for.
Why Use A Buy-Sell Agreement?
In the end, buy-sell agreements that incorporate life and disability insurance yield several benefits to both the company and individual co-owners.
One of the primary benefits to the organization is stability.
Ownership remains within the company instead of roaming around in deceased shareholders’ families, and it allows the company to remain viable over the long term. Insurance policies enable the company to have the funds to maintain this ownership.
Few Tax Implications
The benefits yielded by insurance policies are generally tax-free.
The one major exception to this is in C-corporations, in which the proceeds from the policy may be subject to AMT (alternative minimum tax).
In addition, the premiums paid aren’t tax deductible, so some careful tax planning may be required.
Consistent Share Value
Buy-sell agreements have a way of setting the value of each share of a company.
This can be useful in the event of a dispute in which the purchase price may be subject to discussion. If a buy-sell agreement is in place, a value is established from the outset, making the process much smoother.
Gain An Advantages By Funding A Buy-Sell With Life & Disability Insurance
In addition to the benefits to company succession, permanent life insurance policies themselves can gain value over time, becoming financial assets in their own right. This depends on the type of policy, of course, but it’s worth looking into the options when planning to fund a buy-sell with life or disability insurance.
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