Planning for the loss of a business owner or partner is crucial to ensuring the continuity of your business and protecting the financial security of your family and the families of each partner or co-owner.
To protect your business, your loved ones and your co-owners or partners, you can implement what is known as a buy sell agreement, which specifies what will happen to the interests of a deceased owner, partner or shareholder. If your company’s buy sell agreement requires the surviving owners or partners to purchase the deceased’s interests, you can use life insurance—rather than personal funds or business assets—to fund the buy sell agreement.
For many business owners, the simplest option is to purchase a life insurance policy on the life of each co-owner or partner. In this way, funds will be available to complete a buy-out and provide the families of each partner or co-owner a secure source of funds for the value of their interest. Alternatively, the business could acquire insurance on the life of each co-owner or partner and use the insurance proceeds to purchase or redeem the deceased’s interest in the business. The structure of the buyout and insurance funding should be tailored to the objectives of the business owners.
There are three main methods to fund these types of agreements:
Criss-Cross Method
Each shareholder purchases a life insurance policy on the life of the other shareholder(s) and names himself or herself as beneficiary. Subsequently, the shareholders and company complete a Buy/Sell Agreement that requires the surviving shareholder(s) to purchase the shares of the deceased shareholder, usually at fair market value.
Upon death of a shareholder, the surviving shareholder(s) uses the insurance proceeds paid from the deceased’s life insurance policy to purchase the shares from the deceased shareholder’s estate.
Promissory Note Method
With this method, the operating company purchases a life insurance policy on the life of each shareholder. The company is named as the beneficiary of the policies and a Buy/Sell Agreement is put in place requiring the surviving shareholder(s) to purchase the shares of the deceased shareholder at fair market value. Upon the death of one of the shareholders, the company receives the insurance benefit and pays the proceeds to the surviving shareholder(s) as a capital dividend, allowing them to honour the promissory note.
Corporate Redemption Method
The operating company purchases a life insurance policy on the life of each shareholder, and the company is named the beneficiary of each of the policies. This method requires the company to purchase and cancel (or redeem) the shares of the deceased shareholder.