When you went into business, you made a plan: get financing, source your product, develop a marketing strategy. But did you make a plan for what happens when you're not there? If you or one of your business partners were to pass away suddenly, what would happen to your business?
A buy-sell agreement is one way to protect your business using life insurance. It ensures your surviving family a smooth sale of your business interest. It also ensures your business stays in the rights hands after you pass away.
The life insurance that funds your buy-sell agreement will create a sum of money at your death. That money (called the death benefit) goes to your family or estate as compensation for your share of the business. There are several different ways to set this up.
Types of Buy-Sell Agreements
In an entity purchase buy-sell agreement, the business itself buys separate life insurance policies on the lives of each of the co-owners. The business usually pays the annual premiums and is the owner and beneficiary of the policies.
In a cross purchase buy-sell agreement, each co-owner buys a life insurance policy on each of the other co-owners. Each co-owner usually pays the annual premiums on the policies they own and are the beneficiaries of the policies. If your company has a large number of co-owners, multiple policies must be purchased by each co-owner.
A wait and see (or hybrid) buy-sell agreement allows you to combine features from both the entity purchase and cross purchase models. The business can buy policies on each co-owner, the individual co-owners can buy policies on each other, or a mixture of both methods can be used.
Funding a Buy-Sell Agreement
The amount of insurance coverage on your life should equal the value of your ownership interest. Then, when you pass away, there will be enough cash from the policy proceeds to pay your family or estate in full for your share of the business. But if all that is affordable is insurance coverage for a portion of your interest, you might want to go ahead and fund that amount. Later, the company may be able to increase the amount of insurance or use additional funding methods. In the meantime, the agreement should specify how your family or estate will be paid.
Value vs. Time
What if the insurance proceeds turn out to be less than the value of your business interest, due to growth in the business? Your surviving family members might end up getting less than full value for your business interest. Your buy-sell agreement should specify how the valuation difference will be handled.
Conversely, the insurance proceeds might be greater than the value of your business interest when you die. Your buy-sell agreement should address this potential situation upfront and specify whether the excess funds will belong to the business, the surviving co-owners, or your family or estate.
Keeping Track of Your Buy-Sell Agreement
Each year, the premiums on the policies must be paid, or the insurance will lapse. Your buy-sell agreement should include a feature requiring ongoing proof of payment. Also, review the amount of insurance regularly. The insurance coverage may have to be increased periodically to reflect increases in the value of the business.
The bottom line? Don't leave your business unprotected. Safeguard your hard work and your employees' future with a buy-sell agreement.