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You’ve spent years building your company. And now you want to ensure that your family, business and employees will be taken care off if you’re no longer able to. A buy-sell agreement could be a solid insurance option to put your mind at ease.
It’s a legally binding agreement between co-owners or shareholders that kicks in if a co-owner dies or otherwise leaves the business. The surviving co-owners or shareholders defined in the agreement can buy the remaining share of the business from the family of the deceased, who then sell their shares.
When taking out a buy-sell life insurance agreement, business partners purchase life insurance policies on the lives on each co-owner, but not on themselves. If a co-owner dies, other co-owners are paid a lump-sum benefit that’s forwarded to the deceased’s surviving family members. This payment allows the owners to acquire the share of business from the deceased while compensating grieving family.
Advantages of a buy-sell life insurance agreement include:
A buy-sell agreement is an integral part of the business planning process. When a partner is unable to continue running the business due to death or disability, this type of insurance agreement can protect the business — especially for the surviving owners.
Buy-sell agreements can extend coverage for events other than death and disability, like:
You fund your buy-sell agreement by purchasing life insurance policy on the lives of your business’s co-owners.
Buy-sell agreements tend to fall within three main types:
A typical buy-sell life insurance agreement includes features that include:
Consider the value of each owner’s share of the business to determine the level of coverage you and your partners need. This value amount should reflect the sum insured on the buy-sell life insurance agreement. And business owners should review this amount annually to ensure that adequate coverage stays in place.
For example, if a business has two owners and each has an equal share of the business that’s valued at $2 million, the amount insured on the life of each partner should be $1 million on a buy-sell life insurance agreement.
The value of your business for a buy-sell life insurance agreement depends on business income, tangible and intangible assets. Valuation methods fall into three main types.
This formula should reflect an industry standard that’s appropriate for the specific business. Business owners should assess the value of the business at least annually using this formula to determine whether it’s realistic.
Ask your business accountant to conduct additional assessment on the valuation and confirm whether it’s acceptable on ordinary commercial terms, which may be an underwriting requirement depending on the amounts insured.
This unbiased process helps determine the value of a company while considering each owner’s best interests. Each party involved is allowed to insert their two cents about the buy-sell agreement if only one valuation firm is chosen for the task.
When each owner hires separate valuation firms, the process is taken a step further to reach a compromise between the two valuations. Third-party firms back up their valuations with market research and clear analysis of the company.
Before a trigger event occurs, owners of the business can come together to discuss the value of the business among themselves. After they agree on the value of the business, document and revisit the value with shareholders each year to keep up with the market price.
Two drawbacks of this method are that it may be hard to come to an agreement and the value of the company isn’t calculated by business valuation experts.
When life insurance is used to fund a buy-sell agreement, business owners or partners must consider an ownership structure that’s
A key employee takes out a life insurance policy on the life of the business owner. When the owner dies, their share of the business is bought by the key employee using the death benefit.
Guide to key man insurance
Each shareholder owns an insurance policy on the other owners of the business. If an owner dies or becomes permanently disabled, surviving owners can use the insurance benefit to purchase the departing owner’s share of the business. A buy-sell life insurance agreement with a cross-ownership structure puts in place the requirements for the transfer without compromising the company’s liquidity needs.
The business partners do not own life insurance policies on one another. Rather, the corporate entity owns the insurance policies on behalf of the owners of the business. If an owner dies or suffers a permanent disability, the entity buys out the departing owner’s share of the business using the proceeds from the insurance policy.
Once the company purchases the interest of the departing owner, it doesn’t mean that the shares of surviving business owners automatically increase. This is because they don’t buy the shares in their own names. The percentage of ownership of each surviving owner increases, however.
A buy-sell agreement with corporate ownership is typically easier to put in place for a company with multiple owners. The company buys an insurance policy on each of the owners, rather than all the owners buying policies on one another.
Unexpected death, illness and injury can greatly affect the financial well-being of a business. You and your partners are exposed to the risk of significant financial loss should key stakeholders in your company die or suffer major disabilities.
A buy-sell life insurance agreement is designed to help you eliminate unpredictability and ensure a smooth business transition — even in difficult times.
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