A buy and sell agreement is an approach used by sole proprietorships, partnerships, and closed corporations to divide the business share or interest of a proprietor, partner, or shareholder. While businesses hope they have enough cash available to buy a partner’s interests after a death, that’s not always the case. Even if there is enough cash available the lack of pre-planning can create an issue when valuing the business after a death has accrued. A buy and sell agreement requires that the business share is sold according to a predetermined formula to the company or the remaining members of the business. In order to ensure the availability of funds in the event of a partner’s death, most parties will purchase life insurance policies on the other partners. In the event of a death, the death benefit from the life insurance policy are used to purchase a portion of the deceased’s business interest.
Businesses with one or more partners should implement and fund a buy sell agreement. By implementing a buy sell agreement it ensures that the business will continue and how the succession is handled upon death of a partner. It also insures that the remaining business owners will have the funds to fulfill the agreement. A buy sell agreement can also include other evens such as the disability or retirement of an owner when permanent life insurance is used compared to term life insurance. Excess proceeds from the life insurance can be used to help find a replacement for the deceased partner if one is needed.
Most business owners choose permanent life insurance policies to fund their buy sell agreements. Permanent life insurance policies are often the most affordable option and offer the flexibility that will generate the cash needed to execute the agreement whether it’s due to death, disability or retirement.
Before buying life insurance to fund the agreement, the owners need to know how much coverage to purchase on each other. There are several ways to value a business and the owners must agree, which formula to use. Owners can select a fixed amount per share and as the business grows they can reevaluate that amount and increase the death benefits. Owners can also use a fair market value or book value.