Buy-sell agreements are legal contracts used by business owners, most often for businesses with more than one owner. A buy-sell agreement is essentially an agreement between the owners that, upon the occurrence of a triggering event for one of the owners, the remaining owner(s) will buyout the shares of the owner with the triggering event. Buy-sell agreements specify the buyout terms, including either a price or a valuation method, so there is not disagreement about this at the time the agreement needs to be enforced.
The events covered by buy-sell agreements typically include an owner’s death, disability, retirement, divorce, or just the desire to exit the business. These types of agreements help protect all of the owners from potentially catastrophic loss, and help ensure the business can remain afloat no matter what happens in the lives of the owners.
While in writing and on paper the agreements make sense, they won’t help in practice if the remaining owner(s) do not have the funds available to buyout the other shares when one of the owners dies. Because of this, life insurance is a common tool used to “fund” buy-sell agreements.
Using life insurance as a funding mechanism, either the individual owners or the company purchases life insurance policies on the lives of the other co-owner(s) so that if one of them dies, the policy proceeds are then paid out the policy owner(s) and can be used to buyout the shares of the deceased owner.
The use of life insurance works better in some scenarios than others; for example, it may not be a viable solution if one of the owners has a health condition that makes them uninsurable.
There are many options and variables to evaluate when considering how to structure and fund buy-sell agreements. Contact Chandler & Knowles CPAs today to learn more.