Shareholder Buy-Sell Agreements

shareholder buy-sell agreements

A buy-sell agreement is the will for the business and it eliminates a lot of difficulties and heartaches when a person dies.  A plan needs to be in place and a method of funding that plan must also be available.  Sole proprietorships, partnerships and corporations all need to consider what happens if the owner or one of the partners or shareholders dies or becomes disabled.  Who will purchase the company or the deceased partner’s or shareholder’s interest?  What is a fair price?  When will the sale be made?

The business itself may also suffer from a supplier’s or creditor’s perception of the value of the deceased person to the success of the business.  Key employees may consider the deceased’s death as a reason to move elsewhere.  There needs to be continuity and a smooth transition in the business when tragic events such as deaths and disabilities occur.  The buy-sell agreement is important to resolve a lot of problems dealing with employees, creditors, suppliers and the deceased person’s family.

WHY DOES A SOLE PROPRIETOR NEED BUY-SELL INSURANCE?

Unless a sole proprietor has a family member or a close relative to turn the business over to and feels comfortable the owner’s desires for his/her family members will be served, the options are limited.  The business can be closed, or it can be sold to an outsider or one or more competent and faithful employees.  The buy-sell agreement to a trusted employee works like this:

  • An agreement is prepared which sets forth the employee’s obligation to buy, the price the employee(s) will pay for the business and the method of payment
  • The employee takes out a life insurance policy on the owner.  The employee is the owner of the policy, the person who pays the premium and the beneficiary.

If the owner dies, the death benefits of the insurance policy would be used to buy the business from the owner’s estate.

WHY DOES A PARTNERSHIP NEED BUY-SELL INSURANCE?

Because partnerships are automatically dissolved with the death of one partner, a buy-sell agreement is very important.  The agreement would sell the deceased’s interest in the company to the surviving partner(s) at an agreed price.  Here are some details about the cross-purchase plan.

Cross-Purchase Plan – In this plan each partner buys a life insurance policy on each of the other partners.  The partnership itself is not a participant in the agreement.  Each partner owns, pays the premium payments and is the beneficiary of the insurance policies on the other partners in an amount equal to his share of the purchase price set forth in the buy-sell agreement.   The proceeds are used to purchase the partner’s business interest from the heir’s of the deceased.  The number of policies required for a partnership with multiple partners would be:

the number of partners X (number of partners – 1)

For example:  a plan for a partnership with three partners would require six separate insurance policies.  Each partner would need a policy on each of the other parties.

The premiums are not tax-deductible; therefore the benefits are tax free.

WHY DOES A PARTNERSHIP NEED BUY-SELL INSURANCE?

Unlike a partnership, a corporation does not cease to exist with the death of one of its shareholders.  Without a buy-sell insurance policy the death of a key shareholder may cause legal and financial complications as well as impaired credit.  There are two types of plans available for shareholders:

Cross-purchase plan – each stockholder owns, pays for, and is the beneficiary of the life insurance policy on the other stockholders in amounts equivalent to his or her share of the purchase price.  The corporation is not a party to the agreement.  The surviving stockholders purchase the interest of the deceased stockholder as individuals from the deceased stockholder.  This plan is like the cross-purchase plan described in the partnership section.

Stock-redemption plan – the corporation, rather than the stockholders, purchases the insurance policy, pays the insurance premiums and is the beneficiary on the lives of each shareholder.  The amount of insurance on each stockholder is equal to the proportionate share of the purchase price.  Upon the death of one of the stockholders, the death benefits are paid to the corporation who then buys the deceased’s stock from the deceased’s estate.  Premiums are not tax-deductible; therefore, the proceeds will be received tax free.

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