Funding a Succession Plan with Insurance
Death, disability, divorce, and bankruptcy are just a few of the events that can threaten the future of a once-thriving business. What would become of your life’s work if you decided to retire or had to leave suddenly for another reason?
In the midst of an emotional transition, it may be difficult or even impossible for surviving family members and/or co-owners to come to terms.
A properly drafted buy-sell agreement is a contract that establishes how ownership shares should be transferred when specified triggering events occur. Even though pre-negotiating who will buy out a departing owner may be a good idea, it could prove impossible if the timing of the sale is unexpected and the buyers don’t have the money to close a transaction. For that reason, it may be helpful to fund a buy-sell agreement with life and/or disability insurance.
Two Ways to Go
A buy-sell agreement can be structured to fit the business’s unique circumstances. A sale price is set in the agreement, or a formula is agreed upon for calculating the price at the time of the purchase to account for any changes in the value of the business.
A one-way agreement states that a specific person will buy the business when the owner retires, becomes permanently disabled, or dies. Permanent life insurance could be purchased on the owner’s life, with the successor as owner and beneficiary of the policy. The successor can use the proceeds from the policy’s death benefit to buy the company from the owner’s estate, with the monies passing through to heirs. Otherwise, the cash value that the policy has accrued could help fund the purchase of the business when the owner retires.
A cross-purchase agreement is for a business with multiple owners. It stipulates that the remaining owners will purchase the interest of the departing owner. Each owner could purchase insurance on the lives of the others and would be responsible for premiums on these cross-owned policies.
The guaranteed liquidity provided by insurance may help prevent surviving family members and/or co-owners from being forced to sell assets or borrow money.
The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing an insurance strategy, it would be prudent to make sure that you are insurable. Any guarantees are contingent on the financial strength and claims-paying ability of the issuing insurance company.