Setting up a Buy Sell Agreement

Owners of small businesses are typically focused on day to day operations of their company. As a result, many businesses do not prepare for continuing the business after an owner’s death. To prevent this unfortunate occurance, business owners may enter into agreements with each other—known as buy sell agreements—to assist in the sale of their business interests in case of disability, or death.

One type of buy sell agreement is known as a Cross-Purchase Buy Sell Agreement. In this type of structure, the owners agree to buy and sell their business interests to one another at a set price upon disability or death.

Rather than rely on borrowing money to fund the purchase, each owner buys a life insurance policy on the other business owner. The life insurance proceeds are then used to fund their obligations to each other.

This type of buy sell agreement may be funded with permanent life insurance and the policy cash values may be used to supplement a buy-out at retirement if an owner wants to sell their interests before death.

Advantages of a Life Insurance Funded Cross-Purchase Buy Sell Agreement:

• Creates a strategy to dispose of an interest in a business at death.
• Provides the deceased’s family with an obligated buyer at a predetermined price
• Obligates the deceased’s family to sell the business to the surviving owners. By doing so, this prevents unintended transfers to people outside of the business
• The life insurance provides immediate funds to the surviving business owners to complete the purchase. Each surviving owner receives the death benefit from the insurance income-tax free in order to purchase for the acquired business interest.
• Depending on the state, buy-sell agreement policies may be insulated from creditors of the business

Cross-Purchase Buy Sell Agreement Concerns

Some Concerns in using a Life Insurance Funded Cross-Purchase Buy Sell Agreement

• They can be to design for multiple owners because it may require many policies (e.g., 9 policies for 3 owners). To help to reduce the number of policies, other strategies such as an Entity Purchase Buy Sell may be considered.
• There is always the possibility of a life insurance policy lapse may occur if an owner doesn’t pay their premiums when due.

The above flow chart shows a Cross-Purchase Buy Sell Agreement among three equal owners.

Step 1, each owner involved gets term life rates and purchases life insurance policies on the other. Each owner is assumed to have one-third ownership of the business
Step 2, upon the death of A, the business interests of A pass to their heirs.
Step 3, the life insurance policy’s death benefit on A’s life is paid to the other 2 owners, B and C, who then use the life insurance proceeds to purchase A’s shares from A’s beneficiaries.
Step 4, the interests of the deceased owner’s business are transferred from the beneficiaries of Owner A to the surviving business owners, becoming equal owners as a result. The estate of A will continue to own the other policies on the lives of B and C, which may be sold as a result to the business itself or directly to the insureds.

Please email us at info@etermlifeinsurance.net for more information on how to structure a buy sell agreement using term life insurance.