Posted by Paul F. Lynch
As a small business owner, you know that there are many ways to structure the ownership of your business. If you choose to be the only shareholder in the company, it’s easy to set up a plan to pass the ownership of your company down to your estate—your spouse, children or other beneficiaries—after your death.
If you own your business with another person, you need a plan to protect the remaining partner if one of you dies. The remaining partner may wish to assume full ownership of company shares at the time of death, but might not have the liquid funds available to buy them from the deceased’s estate. One way to resolve this issue ahead of time is a buy-sell agreement.
What is a Buy-Sell Agreement?
A buy-sell agreement is a contract between two shareholders guaranteeing that if one partner dies, the other will buy his or her shares. (In a company with more than two shareholders, the agreement would be called a cross purchase agreement.) The agreement infers that the inheriting family members or estate will agree to sell, and the surviving owner agrees to buy. The agreement also ensures that the family of the deceased partner will get fair market or book value for their shares of the business.
A buy-sell agreement is usually funded with a life insurance policy. This way, if one partner passes away, the death benefit of the life insurance policy covers the responsibility of the surviving partner to buy the shares of the business.
Two Ways to Structure a Buy-Sell Agreement
One of the most important considerations in structuring a buy-sell agreement is whether to fund the agreement for fair market value or for book value.
- Book Value is the value of the company based on the balance sheet. This will roughly equal the net worth of the company for the percentage held by each shareholder.
- Fair Market Value is determined by an independent party. It removes emotion from the equation and simply represents what an unattached, but interested, party might pay.
Another consideration is the condition under which the buy-sell should be executed. Death is not the only event that can incapacitate a business partner. Disability, retirement, or resignation can all be actionable events in the agreement, but these events cannot be funded by life insurance.
To learn more about using life insurance to protect your small business, call SBLI at 1-800-438-7254.