As a business owner, you may have invested significant time, money and effort in your company. Will your business live on if something happens to you or another key employee?
Now is the time to put a plan – and funding – in place.
Three groups could be affected if you don’t.
1. Your family.
Unable to secure a buyer for the business and desperate for cash, your family may sell it to a major competitor for less than its value. This is even more likely if you’ve used debt to secure the business.
2. Your partners.
Since your share of the business will pass to your heirs, your partners could find themselves in business with your family members (whether they like it or not). Even if your heirs agree to sell your share, your partners may not be able to afford it. And, in some cases, the family forces the sale or liquidation of the company.
3. Your employees.
The business may struggle without you or a succession plan, costing employees their jobs, income and health benefits.
A buy/sell agreement, properly funded with individual life insurance, can avoid these outcomes. It can protect your family from debts, ensure an orderly transfer of business interests and help minimize disruption to the business.
How does a buy/sell arrangement work?
There are two key parts of a buy/sell arrangement: the agreement and the funding mechanism. The buy/sell agreement creates a blueprint of who is to buy the business and for what price.
Life insurance is an efficient, reliable way to provide surviving owners the funds they need to purchase the agreed-upon share of the company.
Buy/sell arrangements are usually used in businesses with multiple owners, although in some circumstances a one-way agreement can be useful to single-owner businesses. In a one-way agreement, a third party agrees to purchase the business in the event of the owner’s death.
Life insurance for buy/sell arrangements can take on many forms. One of the most popular models is the cross-purchase agreement in which business owners purchase policies on one another. When one partner dies, the other partner(s) receives the death benefit, which is used to purchase the deceased partner’s share of the company.
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Is a buy/sell arrangement right for you? 9 critical questions.
- Do you own a closely held or family business?
- Could your business benefit from a written continuation plan that dictates how each owner’s interest would be managed in the event of death or departure?
- Could your business be adversely impacted if you died or departed?
- Could your business be adversely impacted if one of your business partners died or departed?
- If a business owner dies or departs, would it be helpful to have already agreed upon the value of his/her business interest?
- If a business owner dies or departs, would it be helpful to have pre-established the obligations or rights of buy-out?
- Are you interested in protecting your business interests in case of intervening life events of a business partner – such as divorce, disability or a serious dispute?
- Could your company’s creditworthiness be helped by having a buy/sell agreement in place?
- Would you like to protect your family from the confusion and stress of negotiating their share of the business after you’re gone?
If you answered “yes” to even one of these questions, don’t wait to put an agreement in place.
Case in point.
John and Mark owned an accounting firm with 35 employees. The firm grew rapidly, so they decided to open a second location. This investment depleted the company’s cash reserves but was expected to yield many rewards over time.
What they didn’t foresee was Mark’s bicycling accident. One day, while cycling, he was hit and killed by a car. John was left without a partner at a time when the business couldn’t afford to buy out Mark’s ownership interest. And, with two kids in college, John couldn’t personally afford the investment either.
Fortunately, the two had a buy/sell agreement in place and had taken out a life insurance policy to provide the funding to execute it. Upon Mark’s death, the policy paid John a benefit equal to the agreed upon price according to the buy/sell agreement.
John was able to secure full ownership and Mark’s family benefited from the sale of the business in a smooth and timely way. Furthermore, no jobs were lost and customers continued to receive the services they counted on.
Note: This scenario is hypothetical and used for illustrative purposes only.
Plan now.
Every business that would be adversely impacted by the death of an owner should consider a buy/sell arrangement.
Just as families have wills to designate the allocation of their assets and guardians for their children, businesses might use a buy/sell arrangement funded with life insurance to outline and fund the terms of business continuation.
This article is not intended to be used, nor can it be used, by any taxpayer for the purpose of avoiding U.S. federal, state or local tax penalties. It is written to support the promotion of the matter addressed here. Grange Life Insurance Company does not provide tax, accounting or legal advice. Any taxpayer should seek advice based on his/her particular circumstances from an independent tax advisor.
All life policies are underwritten by Grange Life Insurance Company, Columbus OH, or Kansas City Life, Kansas City, MO, and are subject to underwriting approval. Not available in all states.