Buy Sell Agreement

Life Insurance

Overview

Buy Sell Agreements are an essential part of prudent risk management and succession planning for any closely held business…whether it is a partnership or family owned business…an,d life insurance is the best way to fund these agreements.

From an unexpected passing of a business owner, the deceased’s ownership interest often times passes to their family who may not have the skills or the interest to carry on the operations of the business.

A buy-sell agreement is a legal contract stating that the deceased’s interest in the business is purchased from their heir’s.  

Rather than purchase the business interest outright through cash on hand, a loan, or purchase over time, life insurance provides the immediate, tax-free cash to purchase the remaining shares from the deceased’s family.

 

Yes

Business Succession Plan?

No

Buy Sell Agreement Strategies

A One Way Buy Sell Agreement usually envolves a scenario where the business has one owner or majority owner with key people responsible for the strength of the company and the skills to run the business after the owner’s passing.  The Buy Sell Agreement states that if the business owner dies, the key employees will recieve the life insurance death benefit to purchase the business from the deceased’s owners heirs.  The life insurance policy in this strategy  is also known as a Key Man Policy.

 

One Way Buy Sell Life Insurance Policy Design

Stay bonus life insurance

 

Buy Sell Agreement Parties

business succession agreement

Life Insurance Beneficiaries

Key Employee Benefit Life Insurance

A Cross Purchase Buy-Sell Arrangement ensures business continuity and maintains marketablility in the event of an owner’s death.  This will also guarnatee a buy for shares of the business, provides liquidity for a deceased owner’s family and avoids conflict of interest between surviving owners and the family of the deceased owner. 

The agreement provides that on the death of one owner, the surviving owner(s) will buy the deceased’s owners share of the business with cash..  Each business owner applies for and owns a life insurance policy on the other owner(s).

Life Insurance Policy Designs

business partner life insurance

 

Life Insurance Proceeds

buy sell life insurance payout

An Entity Repurchase Agreement envolves multiple owners of the business.  The owners enter into an agreement (prepared by an attorney) stating that should any owner die, the business will purchase the shares from that owner’s heirs.  The business purchases life insurance policies on each owner, and is the sole beneficiary.  The beneficiary proceeds provide the business with income tax free funds to purchase the deceased’s share’s from the surviving heirs.

Life Insurance Policy Design

buy sell entity repurchase agreement

Life Insurance Proceeds

death benefit from buy sell agreement

A Cross Endorsed Buy Sell Arrangement is a business succession strategy in which the business owners purchase life insurance policies on their own lives, and “rent” a portion of the death benefit to the other owners.  The rented portion of the deatch benefit serves as a source of funds with with to purchase shares of a deceased owner.  The Cross Endorsed Life Insurance can have a dual purpose, both satisfuing the succession planning of the business, while also establishing an Supplemental Executive Retirement Plan through the cash value build up within the policy.

 

Cross Endorsed Life Insurance Policy Design

buy sell cross endorsed life insurance

Cross Endorsed Life Insurance Proceeds

buy sell cross endorsed strategy

A Lifecycle Buy-Sell Arrangement is an agreement that can ensure the smooth transition of business ownership in the face of the loss or disability of a business owner.  Business owners create a new entity (usually an LLC) to own the life insurance policies on each owners lives.  Owners contribute money to the entity to pay the life insurance premiums.  In the event of a buyout trigger, policy values or death benefit can be used to fund the buyout.

This strategy segregates the life insurance from the other business assets for creditor protection.  A lifecycle buy sell uses cash value life insurance (not term insurance) that can grow in value over time and provide a source of funding for other business owner life stages, such as a downturn, disability, or departure from the business.

Lifecycle Buy Sell Agreement Design

business owned life insurance strategy

Key Points

Business Succession Funding

Without a Buy Sell Agreement, the deceased’s family usually inherits the business ownership portion, and may not have the skills or the interest in being involved in the business.  Many family memebers would rather just recive financial compensation, and many partners would rather acquire the shares.

There are three primary methods of funding the Buy Sell Agreement:

  1. Purchase from cash on hand or a loan
  2. Purchase through an installment plan that may take a decade or more to acquire the deceased’s shares
  3. Life insurance, which provides tax free cash on hand to purchase the shares in a timely manner.
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Policy Ownership

Life insurance policy ownership depends on the strategy and the Buy Sell Agreement structure. 

In a one-way buy sell structure, the business owns the policy on the business owner, while a key employee (or employees) are the beneficiaries.

In a cross-purchase buy sell agreement, each co-owner owns a life insurance policy on the other co-owners.

An Entity Repurchase Buy Sell Agreement is structured so the company owns life insurance policies on the owners, and is the sole beneficiary.

A Life Cycle Buy Sell Agreement involves creating a seperate entity (usually an LLC) to own permenent cash value life insurance policies on the owners.  The owners contribute money to this entity each year to pay the life insurance premiums.  In the event of a buyout trigger, policy values or death benefits can be used to fund the buyout.

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Fund Business Expenses

Funding a Buy Sell Agreement with permanent life insurance gives the company access to tax advantaged funds during economic downturns or other unexptected losses or expenses.  Rather than utilizing business loans or lines of credit, the company can take loans from the policies possibly at a lower rate.  Some policies offer participating loans which allow the policyowner to continue earning interest on the amount taken as a loan.

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Flexibility

Funding a Buy Sell Agreement with life insurance provides the greatest amount of flexibility to the business and the business owners. 

If funded with term insurance, it provides the most cost effective way to secure business interests while keeping existing capital in place for normal business operations.

If funded with permanent insurance, the policy can provide tax efficient loans at favorable rates that may give the company arbitrage opportunities if the loans are participating. 

Furthermore, if the permanent policy remains owned by the company, the eventual tax free death benefit payout can be used to fund the companies employee benefits programs.  

The agreements may also be structured so that upon retirement of the insured employee, the policy ownership is transferred from the company to the employee.  If the policy is a permanent life insurance policy, this can be utilized to provide tax advantaged distributions to supplement retirement income.

Frequently Asked Questions

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What is a Buy-Sell Agreement?

In a buy and sell agreement, the owner of the business interest being considered for reallocation must be deceased, disabled, retired, or have expressed interest in selling. The buy and sell agreement requires that the business share is sold to the company or the remaining members of the business according to a predetermined formula. Before the interest of a deceased partner can be sold to the company or remaining partners, the deceased’s estate must agree to sell.*

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Why do I need a Buy-Sell Agreement?

Buy Sell Agreements are used to protect the business and the interests of the owners by restricting the sale of shares to outside parties without remaining owners approval.  In the event of an owners death, the agreement will prevent the deceased owner’s interest from entering into the estate that may have conflicting interests.  Provides the business with an immediate tax free death benefit to fund the purchase of the remaining shares in the event of an owner’s passing.

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Why do I need life insurance for a Buy-Sell Agreement ?

There are three primary methods of funding a Buy Sell Agreement:

  1. Self funding with cash on hand for payment in full or structured payments.
  2. A loan or line of credit
  3. Life insurance

Life insurance provides a quick, tax efficient method, while retaining all other forms of cash and credit for regular business operations.

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Permanent or Term Insurance ?

That depends on the purpose of the Buy Sell Arrangement.  Many business owners elect for term insurance due to it’s relatively minor costs and the finite time the agreement may be in place.  Owners who desire to build up tax advantaged cash value for the business and possible take ownership to provide tax advantaged distributions in retirement elect a permanent policy design.

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* Investopedia.com, Buy Sell Agreement Definition. 2019. https://www.investopedia.com/terms/b/buy-and-sell-agreement.asp