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One of the most powerful business tools is a buy sell agreement. The proper use of this document can have a direct and dramatic effect on the security of your business. One of the mistakes an ill informed business owner may make is to fail to prepare for the funding of this instrument. Let us take a look at how a buy sell agreement is used and why it is so necessary in virtually every type of business whether it be a sole proprietorship, a partnership, or one of the various types of corporations.
Sole Proprietorships
You have a thriving business that is totally owned by you. As the personal assets of the sole proprietor and those of the business are one the business has to be dissolved upon his or her death. The greatest problem with such a situation is that there will be no more income for the family. In some cases, however, the business can be purchased from the estate by one of the family members. If this family member has the knowledge and experience to continue the business upon the death of the proprietor a buy sell agreement can be set up during the lifetime of the proprietor that would facilitate transfer to this family member.
Some sole proprietorships have a very valued employee that have put a tremendous amount of his or her time and effort into building the business. In such a situation, if the owner has no family member that he wants to have the business upon his death a buy sell agreement can also be set up before hand giving this employee the opportunity of purchasing the business from the estate.
The agreement would be funded by life insurance...the least expensive way to go. In the case of the key employee it could be paid for from his salary or the proprietor could choose to pay for it. In some cases the cost is shared by the business owner and the employee. This agreement would be drawn up by an attorney.
Business Partnerships Or Corporations
A buy sell agreement can be used by a partnership or corporation to distribute shares of deceased partner or shareholder. Although it could be funded using cash or by taking out a loan the best way to go is usually through a life insurance policy. The life insurance can be owned by each partner or stockholder or it can be owned by the business itself. Upon the death of the shareholder the business buys the shares from the heirs for a predetermined price. The buy sell agreement is binding. The heirs will get a fair price for the deceased stock and each of the surviving partners or stockholders will own additional shares. Everyone involved will be happy.
A common business use of term life insurance has been the buy sell agreement. It's especially useful in small businesses or partnerships where the death of one person can significantly affect the continuing functioning of the business at hand. Let's look at the buy sell agreement and how affordable term life rates address the underlying insurance need in such as scenario.
Let's face it...one of the few ways to get ahead in the U.S. is to start your own small business. The average size of companies in the U.S. is between 3-5 people. The big headlines may be for large corporations (and recently, their layoffs) but the engine of this country is small business. The two or three person corporation, partnership, or LLC is very common especially for younger companies. In such a company, each partner typically has to wear many hats and the the loss of any partner would significantly affect the ability of the company to remain an ongoing concern. There's also the contractual obligations and contracts that bind the partners together in the first place. What happens if one partner passes away.
This is where buy sell comes into play. Essentially a buy sell agreement is between the partners or owners of the company. It states that if one person passes away, the other person will buy out their stake in the company. Since this can be large sums of money, the best way to do this is with life insurance. Term life insurance is so inexpensive that it provides a simple and effective means to providing the cash needed so that the surviving partner can buy out the deceased partner's share of the company. In this case, the beneficiary of the term life policy would be the other partner. It's important with life insurance to have an insurable interest. This means that you have some vested interest in another person. The partnership or company ownership establishes this interest.
The reason for a buy-sell is pretty obvious. Let's take an example. Let's say that two partners have opened a company together. It's a straight partnership with 50/50 ownership. They both put in $75K each to start the company which was a large investment for both individuals. The unforeseen happens and one partner passes away. Now what? Most partnership contracts and/or incorporation papers deal with what happens when one partner no longer wants to participate or passes away. It usually involves the other partner(s) "buying out" the shares of the leaving or deceased partner. At a minimum, the surviving partner above must now come up with another $75K. He/she may not have this amount or coming up with this amount of money suddenly will put a severe financial burden on him/her. Or worse yet, what if the person cannot come up with the $75K? There may be surviving family members who require that the contract be fulfilled and the deceased partner's share be purchased with the money going to the surviving family or the deceased's estate.
It's best to avoid these issues altogether with a simple buy sell agreement based on term life insurance. Term is cheap life insurance so it makes it very easy to these issues. You can look at term life insurance on an individual basis and even as a small group (business term life insurance). The latter may offer better rates and more flexible underwriting requirements. We would be happy to run both options to see what makes the most sense. You can request this service with our fast life insurance quote form.