Protecting Your Business Interest with Life Insurance

We always talk about the important personal uses of life insurance.  But did you know that life insurance is an important tool in business planning as well?  Life insurance can ensure a smooth transition for your beneficiaries and your partners if you were to die unexpectedly.  With the proper use of life insurance in business planning, you can be assured that your heirs will get the full value of your business shares without the potential hassle of long, drawn out court proceedings to determine the fair value of your business shares, should you pass away unexpectedly.  This protection can be accomplished by using life insurance for a cross purchase buy/sell agreement.

How Does a Cross Purchase Buy/Sell Agreement Work?

A cross purchase buy/sell agreement is simply a contract stating that your shares will be proportionally purchased by the surviving partners for a predetermined amount at your death.   When using life insurance, a partner/s will take out a policy on your life and they will be the beneficiary.  If you pass away, the surviving partner/s will receive the death benefit.  They are bound by the buy/sell agreement to use the funds from the death benefit to purchase your shares for the predetermined amount agreed upon in the agreement.

 Benefits of a Buy/Sell Agreement

Benefits to Beneficiaries             

• Your beneficiaries are ensured a buyer as well as a fair market value for you shares.
• They avoid potential court proceedings to value your portion of the business or get the funds for your portion of the business.
• They do not become owners of a business that they do not want or know nothing about.

Benefits to Surviving Partners

• Your surviving partners get tax free liquidity from the life insurance policy they need to purchase your shares.
• They do not get any unwanted partners that might purchase or inherit your shares.
• The business does not suffer as the buy/sell agreement creates a smooth transition at your death.

Disadvantages of a Buy/Sell Agreement

• Premiums are paid with after tax dollars and are not a business expense.
• Premiums are an ongoing expense that must be paid.
• Some owners may be older or uninsurable compared to other owners.
• Ownership percentages may vary, allowing minority owners to purchase more insurance.

There are many things to consider when crafting a cross purchase buy/sell agreement so that it is fair to everyone involved. The agreement should require some form of ongoing proof of payment to ensure that all polices are kept in force.  It is best to consult with a legal professional when drafting such an agreement to ensure that all potential issues are addressed.

Business Value

When you enter into a cross purchase buy/sell agreement, you must determine the value of your share of the business.  This can be a complicated or simple process depending on the type of business you own.  The value of your share could rise or fall over time.  The buy/sell agreement should address how any valuation difference will be handled.

Life Insurance Options

Term or permanent coverage can be used for a cross purchase buy sell agreement.  Term insurance is simple in that it provides coverage for a predetermined period of time such as 10, 15, 20, 25 or 30 years.  This might be a good product to use if you only want to keep a cross purchase buy/sell agreement in effect for a specified period of time.  You might have an agreement with your partner to sell the business at a future date, so you just want to be protected until then.  This is the most cost effective way to fund a cross purchase buy/sell agreement with life insurance.

Permanent insurance is another option and provides coverage for your entire life.  It is more expensive than term insurance, but it builds cash value that can be accessed in the future during retirement.  Permanent insurance is “open ended” in that it can last through retirement if you plan on keeping the agreement that long.

As mentioned previously, the value of the company could increase in the future.  Whether you use term or permanent coverage, you should use a life insurance product that allows flexibility with regards to the death benefit.  For instance, a policy with a guaranteed insurability feature allows you the option to purchase more insurance at future dates.

Another Type of Buy/Sell Agreement Using Life Insurance

The cross purchase buy/sell agreement is just one type of agreement.  There is also the entity purchase or stock redemption plan where each owner enters into an agreement with the business for the sale of their respective interests to the business.  The business owns and is the beneficiary of each owner’s policy.  The business also pays the premiums.  The entity purchase agreement cuts down on the number of policies that must be purchased compared to a cross purchase buy/sell agreement and could be easier to manage, especially if there is a large disparity between owner’s ages.

Conclusion

Life insurance is an excellent product to use in business planning.    It can help ensure that the legacy you helped build will remain intact after you are gone and your loved ones will be taken care of should you die unexpectedly.  You should always consult with a legal professional to make sure that your buy/sell agreement is properly drafted.  You should also consult with a tax professional in order to understand any tax consequences that can arise in these types of agreements.  If you’re a business owner and you think a buy/sell agreement would be a good fit for your situation, we would be happy to show you your options.   We have access to over 40 insurance companies and will use all of our resources to get you the best coverage option available. Please feel free to give us a call at (888) 687-9444 or email us at info@archstoneagency.com if you have any questions.

About Us

Archstone Insurance Services, LLC is an independent agency that shops over 40 of the top life insurance carriers to provide huge savings on life insurance coverage for our clients.  We are happy to answer any questions you might have about any of the insurance products we offer, your planning needs or your existing coverage.  Feel free to call us directly at (888) 687-9444 or email us at info@archstoneagency.com.  You can also visit our website at www.archstoneinsurance.com.