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Buy/Sell Agreement

Ensuring Your Business’s Future with a Buy/Sell Agreement

Your business is built on hard work and careful planning. Unfortuantely, just as some families don't have a will, or life insurance, many business owners neglect to set up a business succession plan funded with insurance. This matters, because just as a will is important for most people to have, a buy/sell agreement is just as important, if not more for your business. Buy/sell agreements ensure the continuity of ownership and management of a business in the event that an owner can no longer continue. Proper advance planning with a buy-sell agreement, usually funded with life and/or disability insurance can prevent liquidity and other issues, and ensure fair pre-determined compensation for the families of deceased or disabled owners.

A well-drafted buy/sell agreement can achieve several significant business goals:

  • Ensure seamless transfer of ownership
  • Maintain business stability and continuity
  • Provide financial security for the departing owner’s family
  • Protect the business from unplanned buyouts

Types of Buy/Sell Agreements

Buy/Sell for Partnerships

Partnerships automatically dissolve upon the death of a partner. Therefore, having a buy/sell agreement is critical. This agreement of purchase and sale of business interests will sell the deceased partner’s interest to the surviving partners at an agreed price. For partnerships, there are two main plans:

  • Cross-Purchase Plan: In this buy sell agreement, each partner purchases a life insurance policy on the other partners. Each partner owns, pays the premiums, and is the beneficiary of the policies. Upon a partner’s death, the surviving partners use the insurance proceeds to buy the deceased partner’s business interest from their heirs.
  • Entity Plan: Here, the partnership itself owns, pays the premiums, and is the beneficiary of the insurance policies. When a partner dies, the partnership buys the deceased partner’s interest from their estate and redistributes it among the surviving partners according to their ownership shares.

While premiums are not tax-deductible, the benefits from buy sell agreement insurance are received tax-free.

Buy/Sell for Closely Held Corporations

Unlike partnerships, closely held corporations with shareholders do not dissolve upon the death of a shareholder. These corporations have two primary buy/sell agreement plans:

  • Cross-Purchase Plan: Each shareholder owns, pays for, and is the beneficiary of life insurance policies on the other shareholders. The surviving shareholders buy the deceased shareholder’s interest from their estate. This buy and sell agreement plan can become cumbersome with many shareholders.
  • Stock Redemption Plan: The corporation owns, pays for, and is the beneficiary of the insurance policies. Upon a shareholder’s death, the corporation uses the insurance proceeds to buy the deceased’s shares from their estate. Premiums are not tax-deductible, but the proceeds from the buy sell agreement insurance are received tax-free.

Buy/Sell for Sole Proprietors

For sole proprietors, the options for a buy/sell agreement are somewhat limited unless a family member or close relative can take over the business. Options include:

  • Sale to Employees: An agreement of purchase and sale of business interests would outline the employees’ obligation to buy the business, the purchase price, and the payment method. Employees take out insurance policies on the owner, and the death benefits are used to buy the business from the owner’s estate.
  • Life Insurance Policy: If no suitable buyer exists, a novel approach is for the sole proprietor to purchase a life insurance policy. Upon the owner’s death, the insurance company pays the family or other beneficiary the death benefit, thus monetizing and replacing the business’s lost value. 

Frequently Asked Questions

What is a buy/sell agreement?

A buy/sell agreement is a legally binding contract that outlines how a partner's share of a business may be reassigned if that partner dies or otherwise leaves the business.

Why is a buy/sell agreement important?

It ensures the smooth transfer of ownership and management, maintains business stability, and provides financial security for the families of deceased or disabled owners.

How does buy/sell life or disability insurance work?

Life insurance policies are commonly used to fund buy/sell agreements. The proceeds from these policies provide the necessary funds to buy out the departing owner's interest, ensuring liquidity and fair compensation.

What are the tax implications of a buy/sell agreement?

While the premium payments for life insurance policies are not tax-deductible, the benefits received from these policies are tax-free.

Need a Buy Sell Agreement?

Advance planning ensures the continuity of your business and fair compensation for all parties involved. Funding your buy/sell agreement with life insurance is an ideal way to make sure everyone is fairly compensated for their ownership interest in the business. If you have questions or want help creating your own Buy Sell Agreement, Contact Newhouse Financial Group–we welcome the opportunity to serve you!

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