As a business owner, have you ever asked yourself the question, “If I die, would my partners want to be in business with my spouse or my children?” There is also the reverse question to consider: “Would my heirs be interested in partnering with the company?” If the answer is “no,” that’s OK; it’s common for surviving spouses to prefer cash, and normal for the remaining partners to be hesitant toward new shareholders. But unless your company is a single-member entity, it should have a business succession plan and a buy-sell agreement in case you or another partner dies or becomes disabled.
A well-drafted buy-sell agreement dictates what will happen when you or one of your partners is no longer part of the company. It helps ensure that your business will continue to be successful, and it provides, upon your death or disablement, a roadmap for the buyout of your interest in the company. When it comes to funding a buy-sell agreement, there are three main options to consider.
Option No. 1: Cash Payment
The company can use cash out of its reserve to purchase the shares from surviving heirs. However, unless the purchase is for 10 percent or less of the ownership, most companies do not have the cash set aside to make the payment.
Option No. 2: Promissory Note Payment
The company can elect to do a buyback for a determined number of years. In a buyback, your shares are redeemed back to the company in exchange for a promissory note. The note is paid over a 10-year period and can provide a solid annuity payment for your surviving spouse or children.
Option No. 3: Life Insurance Death Benefit Payment
Your company can purchase and own a life insurance policy on your life and on the lives of the other primary owners. The company pays the premiums and the company owns the policy. When a member — either you or another insured partner — dies, the company receives the life insurance death benefits. The benefits are first used to pay your heirs 100 percent of the purchase price of your financial stake in the company. Excess benefits remain with the company to assist it through any tough times that are met after your death.
To further understand how you can fund a buy-sell agreement with life insurance, let’s assume your company has two shareholders — yourself and your partner. Each owns a 50 percent interest in the company and your corporate attorney prepared a buy-sell agreement stating that, in the event of death, your shares or your partner’s shares can be purchased for $1,000,000. Your company also carries a term life insurance policy with death benefits of $1,500,000 for each of you. If your partner dies unexpectedly, your company would receive $1,500,000 of death benefits. Pursuant to the buy-sell agreement, your partner’s estate would redeem, or “sell,” all of his/her shares back to the company in exchange for $1,000,000. Your partner’s spouse or children would receive the $1,000,000, and you, the sole remaining shareholder, would own 100 percent of the company. The $500,000 of the remaining death benefits could be used to aid the company through this major event, and could even be used to hire outside consultants or additional personnel.
By funding your buy-sell agreement with life insurance, your surviving family members will be financially sustained and can transfer in a more seamless manner your stake in the company, which ensures that the company will continue to prosper.
To learn more about how you can transfer your business, contact Stuart Boehning at 765-742-9066.
The content of this blog is intended to be general and informational in nature. It is advertising material and is not intended to be, nor is it, legal advice to or for any particular person, case, or circumstance. Each situation is different, and you should consult an attorney if you have any questions about your situation.