Life insurance is similar for a business as it is for an individual in protecting against the financial loss associated with premature death. Though various kinds of companies exist (sole proprietorships, partnerships and corporations), life insurance is necessary to ensure capital is adequate and available if unexpected loss occurs.
The death of a business owner or partner in a business can also bring the end to the business; life insurance plays a vital part in protecting the integrity of a business if such event were to occur. Life insurance, in the form of a ‘buy-sell’ agreement, provides the necessary protection to ensure the survival of the business and a disbursement of ownership rights to remaining partners or owners.
As a licensed insurance agent, it is important to understand the basic concept of a buy-sell agreement as well as the types of buy-sell agreements available to properly insure against the loss of a business owner or partner.
The death of a business owner doesn’t necessarily mean the end to the business. Buy-sell agreements are used to provide structure in the absence of the business owner or partner.
A ‘buy-sell’ agreement, also known as a ‘buyout’ agreement, is defined as a financial agreement or arrangement that protects business partners against financial loss by securing a predetermined fair market value share of a partner that, upon a predetermined event such as death, is sold to the remaining partners in the business to ensure the continuation of the business.
2 types of Buy-Sell Agreements:
Cross-Purchase Plan – This type of buy-sell agreement is typically used between two or three partners within a company. Each partner buys a share of the deceased partner’s interest and is considered the beneficiary of the other partner(s). A stock-purchase plan is set up in the same manner, but is often used at the corporate level to protect a company’s few shareholders. Because these plans involve each partner or shareholder owning a policy on each other partner or shareholder, they are usually used by companies with one to three members. For example, if three partners exist, each partner would own two policies (one on each partner, excluding him or herself) equaling a total of six insurance policies for the company – 3 partners x 2 policies each = 6 total policies.
Entity-Type Plan – In the event that several partners exist, an entity-type plan is often used to simplify the process where the business itself will buy out the deceased partner or owner’s share in the company. A stock-redemption plan is set up in the same manner, but is often used at the corporate level to protect the interest of several shareholders. Because this type of plan usually involves several partners or shareholders, the entity, itself, buys out the shares of each member, so only one policy exists.
Buy-sell agreements legally bind business partners or owners into agreeing to purchase each others’ shares of the company at a predetermined price in the event of death, disability, or other predetermined qualifying events such as at a predetermined retirement age. The following scenario shows how effective having this protection can be: 5 Questions to Ask a Business Owner
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