National Best

Buy / Sell Agreements

What If Your Business Partner Dies – Buy/Sell Agreements

Benefits of an Insurance Funded Buy/Sell Agreement

A buy/sell agreement is a legal document between business owners or shareholders in a company and represents a formalized way to transfer business interests in the case of the death of a partner or shareholder. It is useful to ensure a smooth transition of business ownership and to ensure the ongoing operation of the company.

Life insurance is an excellent way to fund a buy-sell agreement in the case of the death.

What are the benefits for the deceased’s family:

  1. they have a guaranteed market for the business interest
  2. they are guaranteed a fair price
  3. they are not forced to become involved in the business or be dependent upon the remaining owners
  4. it facilitates settlement of the deceased’s estate

What are the benefits for the remaining owners:

  1. the business keeps running
  2. they continue as sole owners without involvement from the deceased’s family
  3. it provides a smooth transfer of the business interest
  4. the sale price, or the method to determine if it is fixed in the buy-sell agreement

What are the benefits for all parties:

There are no surprises! An agreement is entered into when all parties are alive and have input into the details of the business continuation plan

Life insurance funded buy/sell agreements are highly efficient from both the tax perspective and the efficiency of funding. If there were no life insurance to fund the program, the deceased’s estate would have to sell personal assets or pay from their own savings, borrow funds, or pay over time.

In each case, the alternative to life insurance involves more complexities and the potential for the agreement to go unfulfilled or to be more costly.

Life insurance is a much more economical method. It provides immediate cash when required, the annual cost is a fraction of the benefit ultimately paid, the insurance proceeds are tax-free and the business can continue unencumbered.

There are three basic insurance funding methods:

Personally Owned– Crisscross Method
Assuming that each shareholder owns 50% of the company, the agreement would require each shareholder to place insurance on the other shareholder. As an example, shareholder A would take out a life insurance policy on shareholder B. Shareholder A would be the owner of the policy and would also be the beneficiary. Shareholder B would do the same. The buy/sell agreement would specify that should shareholder A die, shareholder B would pay the proceeds of the insurance to A’s estate, and the estate would surrender B’s shares to shareholder A.
The advantages to the personal crisscross method is that it is very easy to understand and it is a simple agreement to construct. Corporate creditors will have no access to the insurance proceeds and the insurance proceeds are received tax-free. Some disadvantages of the crisscross method are that the insurance costs may be inequitable due to the age, health and percentage ownership of the partners. Also, insurance premiums are paid with after-tax personal dollars.
Promissory Note Method
In this method the company would own the life insurance on both shareholder A and shareholder B. This makes the company the owner, and the beneficiary of the policy. Each estate would be issued a promissory note for the agreed to sale price of the company shares. When shareholder A dies the company receives the insurance proceeds which are then transferred to the capital dividend account, paid to shareholder B who then uses the proceeds to repay the promissory note to the estate of shareholder A.
The advantages of the promissory note method are that premiums are paid with corporate dollars which could be an advantage if the corporate tax rate were less than the shareholders personal rate. Also the impact of premium differentials based on age and health is reduced. Some disadvantages are that this method is a more complex process and life insurance proceeds are not protected against corporate creditors at death.
Share Redemption Method
The share redemption method is once again a corporate owned model in which the proceeds of insurance are paid to the company, deposited to the CDA account as before but the proceeds are paid directly to shareholder A’s family from the CDA account in exchange for shareholder A’s shares. As with the promissory note method the advantages are that the premiums are paid with corporate dollars so the impact of premium differentials are reduced. The disadvantages are that it is a complex arrangement, the life insurance proceeds are not protected against corporate creditors at death and no increase is possible in the survivor’s adjusted cost base.
Buy/Sell Agreements are legal documents and they should only be set up with experienced professional help including a lawyer, accountant and licensed insurance professional. Please call us today and we will have our trusted referral partners assist you with a Buy/Sell Agreement.

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