Rice Sullivan & Co.

Fund a buy-sell agreement

A life insurance death benefit is an excellent funding option for buy-sell agreements. Such an agreement provides many benefits (see the sidebar "Why a buy-sell agreement?") but it won't be useful if, when an owner departs, the remaining owners can't afford to buy back his or her shares. That's where life insurance comes in.

Take, for example, Mike, Debbie and Bill, fictional partners in a small manufacturing company. Each owns a life insurance policy equal to the amount of his or her share in the business and has named the other two as beneficiaries.

When Mike dies unexpectedly, the insurance company pays death benefits to Debbie and Bill, who use the money to purchase Mike's shares from his estate. Not only does this keep the company running smoothly, but it gives Mike's family almost immediate access to liquid assets.

Know the advantages

Business owners can fund a buy-sell agreement with other sources. But life insurance offers several advantages. Probably most important, it's the only funding option that virtually guarantees that the full buyout amount will be available immediately upon your death. (This assumes your policy offers sufficient coverage and you've made timely premium payments.)

Also, death benefits aren't subject to income tax so long as the policy is properly structured. Thus, the full proceeds will be available for the buyout. And, if a premature death occurs, the total premiums paid on a life insurance policy normally are a fraction of the cash received as a death benefit.

What's more, if you own a permanent policy that accumulates cash value, this amount also is figured on a tax-advantaged basis. The cash value may be available to help you fund a buyout during your lifetime so that you can retire or move on to other business ventures.

Review periodically

You'll need to review your life insurance policy and buy-sell agreement, along with the value of your business, periodically — say, once a year — to ensure the policy proceeds will be adequate when the time comes. As your business grows, changes direction and even welcomes new owners, you may have to change the benefit amount of your insurance policies. •

Why a buy-sell agreement?

A buy-sell agreement enables a business with multiple owners to specify how company shares will be valued and how and to whom they can be sold or transferred should one of the owners die or wish to sell. This legal document is essential to protecting your business from unwanted shareholders (such as competitors or family members), costly disruptions — even financial ruin.

 

Other articles in the January 2012 Edition of Business Matters: