For business owners, planning for the future is a vital part of being an entrepreneur. Not only is it important for one's personal success, but to ensure the wellness of the business itself. For those companies with multiple partners, a crucial component of long-term planning is a buy-sell agreement. In this article, we're going to discuss what these are and how your clients can potentially fund a buy-sell agreement with life insurance.
What is a Buy-Sell Agreement?
Broadly speaking, a buy-sell agreement is a contract that stipulates what happens to the business when a partner leaves. Circumstances can vary, including death, illness, or retirement. When that happens, the remaining partner(s) will need to buy out that person's stake in the business. Without a buy-sell agreement in place, the remaining partner(s) could be left in a bind, both financially and strategically.
Let's say that one of your clients has a business with another partner, which is worth $1 million. The other partner dies, leaving his half of the company to his family. Your client will need to buy out the former partner's share (valued at $500,000). A buy-sell agreement outlines this whole process so that there are no surprises or problems along the way.
Funding a Buy-Sell Agreement With Life Insurance
So, what happens if your client doesn't have the money to buy out the partner's share? A buy-sell agreement is only worth something if it's funded, which is why your clients need to draft it with a funding resource in mind. Fortunately, getting life insurance policies for all business partners is a viable option in many cases. Let's break down the different ways that life insurance can be used to fund a buy-sell agreement.
- Cross-Purchase - for companies with only two partners, this option works best. Each partner takes a policy out on the other - when one dies, the death benefit pays to the remaining partner, who uses the money to fund a buy-sell agreement.
- Stock-Redemption - in this case, the company holds insurance policies on all partners. When one dies, the death benefit is paid to the business, which exchanges the cash for the partner's stock in the company. Remaining partners will own those shares, but they don't receive a step-up basis, so they will have to pay capital gains taxes if they sell later on.
- LLC Buy-Sell - for those businesses with more than three partners, they can form a separate LLC with identical partner shares and percentages. The new LLC takes a policy out on each partner so that when they die, the benefit goes to the LLC and is distributed to the surviving partners. The partners can then buy our the estate of the deceased partner.
Benefits of Funding Buy-Sell Agreements With Life Insurance
Although your clients can buy out a partner's share in the company through other means, using life insurance is a smart move. While it won't trigger for all situations (i.e., retirement), it can provide peace of mind. Here are the top reasons your clients should get a policy.
- Immediate Benefits - if a partner dies suddenly for any reason, life insurance will pay, even if the policy is relatively new.
- Disability and Other Riders - some life insurance policies can have living benefits for when a policyholder becomes incapacitated. Business owners can still receive payment for triggering events like disability or terminal illness.
- Convenience - buying out a partner can be a complicated process if funding has to come from multiple sources. A life insurance policy keeps things neat and organized.
Contact Advisor's Resource Today
Now that you understand the value of funding a buy-sell agreement with life insurance, talk to your clients about getting a policy for their business. At Advisor's Resource, we know the intricacies of these plans so we can help you make the best decisions for your clients. Call us to find out more.