We have a fabulous guest post from Jason Guttenberg of Ace Insurance Group. He helps explain how a company can use insurance to decrease risk related to death of a shareholder or LLC member. Don’t know much about buy/sell agreements or provisions? Don’t worry, I’ll explain them more in a soon to be coming post, but it isn’t key to understanding Jason’s post below. Trust me, small business owners, you WANT to read this.
Picture a scenario where a business partner passes away unexpectedly. Is there a plan for how the business will survive? If the deceased business partner has a spouse are you comfortable with that spouse as your new partner? Most business owners would answer no. The surviving spouse may have no knowledge of your industry yet they could have just as much say on how the business should proceed. Or even more say in some cases. They could even decide to close or sell the business altogether.
There is an effective strategy to plan for such as an event as this. A buy-sell agreement is a contract between business owners that will spell out the what-if’s of a change in ownership. Similar to an estate plan for an individual.
But how can you afford to buy out your deceased partner?
The use of life insurance is a great way to fund a buy-sell agreement between business partners. Either the company or the individual business owners will take out a life insurance policy on the lives of the other business owners. If one business owner dies the death benefit can be paid to the remaining surviving family members in exchange for their interest in the business. The life insurance can limit or eliminate financial strain on the surviving business partners at the time of purchase. The death benefit can either partially or fully fund the change in ownership.
There are a number of benefits of funding a buy-sell agreement with life insurance.
First, the life insurance creates a lump sum of cash to facilitate the buyout. Thus converting a non-liquid asset to cash. Second, proceeds of life insurance are typically paid quickly. With a well-drafted buy-sell agreement the funds can be transferred quickly. This will limit any business interruption. Third, portions of life insurance death benefits could be income tax free. And could also avoid estate taxes. Therefore maximizing the values of the death benefit.
And finally, if the life insurance policy creates cash value it can be a business asset.
Having a plan when a death triggers an ownership change can save a business from collapsing.
Each business and its makeup of owners is unique. Risks, costs and benefits of a buy-sell should be evaluated carefully. Consulting your attorney for advice on how to structure a buy-sell is recommended.
See, I told you! Great post, Jason. Talk to your insurance agent about this. If they don’t have one or they give you insufficient answers, Jason is a great coffee date. Just sayin’.