What is a Buy-Sell Agreement, and should I have one?

Every business owner should ask themselves one vital question. How will our company continue to move forward in the event of a death, disability, or departure of one of the business owners?
Like a will, a Buy-Sell Agreement spells out how assets and other business interests will be dispersed should an owner quit, become disabled, or die.
Without such an agreement, complications arising from ownership succession may sink any successful company. The remaining owners might be forced to share management and profits with unskilled or contentious outsiders. They may be involved in legal disputes over business assets and liabilities. A firm’s internal quarrels may spill over to customer service, resulting in lost sales. If the firm’s ownership seems doubtful or uncertain, creditors might accelerate collection efforts, bringing unwanted pressure on company resources. Situations such as these illustrate the importance of having a Buy-Sell Agreement in place before the unexpected occurs.
 Funding a Buy-Sell Agreement with Life Insurance
 As a partner or co-owner (private shareholder) of a business, you’ve spent years building a profitable company. You may have considered setting up a buy-sell agreement to ensure your surviving family a smooth sale of your business interest and are looking into funding methods. One of the first methods you should consider is life insurance. The life insurance that funds your buy-sell agreement will create a sum of money at your death that will be used to pay your family or your estate the full value of your ownership interest.
Do I use Life Insurance or Disability Insurance? ….Why not both?
How funding with Life Insurance works
When using life insurance with a buy-sell agreement, either the company or the individual co-owners buy life insurance policies on the lives of each co-owner (but not on themselves). If you were to die, the policy owners (the company or co-owners) receive the death benefits from the policies on your life. That money is paid to your surviving family members as payment for your interest in the business. If all goes well, your family gets a sum of cash they can use to help sustain them after your death, and the company has ensured its continuity.
Advantages of using Life Insurance

• Life insurance creates a lump sum of cash to fund the buy-sell agreement at death
• Life insurance proceeds are usually paid quickly after your death, ensuring that the buy-sell transaction can be settled quickly
• Life insurance proceeds are generally income tax free; a C corporation may be subject to the alternative minimum tax (AMT)
• If sufficient cash values have built up within the policies, the funds can be accessed to purchase your business interest following your retirement or disability

Disadvantages of using Life Insurance

• Life insurance premiums are paid with after-tax dollars because the premiums are generally not a tax-deductible expense
• Premium requirements are an ongoing expense
• One or more co-owners may be uninsurable due to age or illness
• If the co-owners’ ages vary widely, younger co-owners will have to pay higher premiums on the lives of the older co-owners
• If the ownership percentages vary widely, more insurance will be needed to cover the owners with the larger ownership interests, resulting in higher premium costs for those with smaller ownership interests
• Only pays on death

How funding with Disability Insurance works
Disability buy-out insurance is designed to provide the funds needed to purchase a disabled owner or partner’s interest in the business if they become disabled. Disability buy-out insurance should be made part of any business continuation plan or business succession plan as it will assure that the disabled business owner receives a fair market value for his or her interest in the business. At the same time, it will protect all business owners from the threat that a disability may impose on the company by allowing them to buy-out the disabled owner’s interest at an agreed upon price set forth in a buy-sell agreement.
The statistical probability of an individual disability is greater at any age than the likelihood of death in that same year. The disability of an owner who is active in the day to day operations of the business can present huge financial problems. To understand more about the potential threat a disability may be to your organization, ask yourself the following questions: What impact would the disability of a partner who is a key contributor have on the company’s income? Where will the money come from to pay an income to the disabled owner? Does the business have adequate funds to buy out the disabled partner’s share? Will the firm have to borrow money to buy out the disabled partner?
Important considerations of disability buy-sell planning

 
How long has it been since you reviewed your Buy-Sell Agreement?