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Beginner’s Guide to Buy/Sell Protection

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It is important to plan for the future of a business, but life can be unpredictable. A buy/sell protection plan is designed to help keep your business secure if the unexpected should occur. 

What Is a Buy/Sell Agreement?

A buy/sell agreement is a contract between business partners, stipulating how a partner’s interest in the business will be reassigned if that partner dies or leaves the company. Most buy/sell agreements require that the deceased partner’s share be sold to the partnership or remaining partners. This type of contract serves several purposes for business partners. It can help ensure:

  • Your family is provided for in the event of your death.
  • The business continues to operate.
  • A fair price is predetermined for the sale of your business interests.
  • The future is secured for your employees.

How Does Buy/Sell Protection Work?

A buy-sell plan is a legally binding agreement between co-owners of a company. It specifies what will happen should a partner die or leave the business. It is designed to smooth the transition in ownership. The terms of a buy/sell contract establish:

  • The intent of a partner to sell his or her interest in the business to the remaining owners upon his or her death.
  • The intent of the remaining owners to purchase the deceased partner’s business interest.
  • A calculation of the value of each owner’s business interest. 

How Does Life Insurance Fit In?

In case of the unexpected death of an owner, life insurance can provide the funds to purchase the deceased partner’s interest in the business. Under a buy/sell agreement, the heirs of a deceased partner are required to sell their inherited interest in the company at a predetermined price. There are two types of life insurance-funded buy/sell protection plans:

  • Cross-purchase buy/sell protection: Co-owners of a company purchase life insurance policies on each other. Each partner is an owner and beneficiary of the policies of each of the other owners. If a partner should die, each surviving partner receives life insurance proceeds with which to purchase the business interest of the deceased owner. The proceeds are tax-free.
  • Stock redemption/entity purchase buy/sell protection: The company buys a life insurance policy on each partner. In this case, the business itself is the owner and beneficiary of all policies. If one owner dies, the business receives the tax-free life insurance proceeds, which it uses to buy the deceased owner’s interest. 

What Are the Advantages of a Life Insurance-Funded Buy/Sell Agreement?

A life insurance-funded buy/sell agreement ensures that funds are available immediately to buy an owner’s share should he or she die unexpectedly. It establishes a valuation of the deceased person’s interest in the business for estate tax purposes, sets a mutually agreeable price and terms, and helps facilitate a smooth transition. It also provides cash instead of stock for the family members of the deceased and protects the company’s liquidity. 

If you are considering buy/sell protection for your partnership, speak with our knowledgeable agent. We understand the complexities of buy/sell protection insurance and can help ensure your assets, your family, and your business are protected. 

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