Life insurance products can help meet the needs of many businesses, especially those who have shareholders or a partnership. It is important to consider the consequences if a partner dying and the financial impact it could have on a corporation if this partner was essential to the business. In this case it is important for businesses with more than one partner or multiple shareholders to establish buy and sell agreements that outline the terms and conditions where the interest of a deceased member’s will be transferred to other interested parties. For example person “A” will make a binding commitment to purchase person “B’s” financial interest in the company in the event of death and therefore person “B” will direct his/her estate to sell his/her financial interest back to person “A”.
A buy and sell agreement is a legal contract between a buyer and a seller. Each party in the contract can be a sole individual, partner, shareholder or corporation depending on the type of business and circumstances surrounding the agreement. The funds gained by the buyer in the event of the seller’s death, will provide he/she with an adequate amount of money to purchase the business from the estate (i.e. the seller’s family). In the buy-sell agreement, the value and terms of payment will be specified which removes the negotiation period when the agreement comes into effect.
What Type of Buy and Sell Agreement Do I Need?
Depending on the organization of your business there are different buy-sell agreements that can be created to deal directly with your personal situation.
A business run by a sole proprietor means that there is only one individual who owns and runs the business and therefore there is no legal division between the owner and his/her business. Any losses, gains and/or debt are the sole personal responsibility of the owner. With this form of business, the owner typically creates an agreement that will sell the business interest to a specific employee. This agreement can either specify the method by which to transfer the business to the employee, assign a pre-determined monetary value or constitute a formula that will be used to calculate the value.
Once the buy-sell agreement terms have been implemented between the owner and the employee, the employee will purchase a life insurance policy on the life of the owner where he/she will be named as the beneficiary. When the owner dies, the money received from the life insurance policy will be used by the employee to purchase the business from the estate according to the terms specified in the buy-sell agreement.
A partnership includes two or more owners of a business that equally share the losses and profits. Here, depending on the legal jurisdiction, there may be more personal liability for the partners in comparison to a corporation structure; however, there are more tax benefits. A partnership buy-sell agreement sets out the terms and conditions that commit each partner to purchase a percentage of the deceased’s business interest. For instance, a business is owned by A, B and C. In the event that “A” dies it seems only logically that “B” and “C” will equally purchase “A’s” business interests in order to continue running the business as equal partners while also providing “A’s” family with monetary gain from “A’s” sell of interests. This agreement may also set out a formula by which to determine the value of the business at the time of a partner’s death.
Each partner will purchase a life insurance policy on every other member whereby they will become a beneficiary in the policy. He/she will continue to pay the premiums for this policy or multiple policies depending on the number of insurance contracts required to meet purchasing obligations. The monetary benefit from the insurance policies will be used to purchase the business from the estate in accordance with the buy-sell agreement.
Distinct from sole proprietors and partnerships, corporations are separate legal entities from the shareholders and therefore there is no personal liability to members. A shareholder purchases stock from the corporation to invest in that business. With this business type buy-sell agreements can be organized so that shareholders can purchase each other’s shares in the event of a deceased shareholder. Since the corporation is a separate entity it can also participate in a buy-sell agreement to purchase deceased shareholders’ stocks.
As with other business types, life insurance policies are taken out on each shareholder by other shareholders or by the corporation itself to be named as the beneficiary. The proceeds gained from this policy are to be used to purchase the shares from the estate of the deceased member.