Three partners in Winter Park own a commercial roofing company in equal shares. Their attorney drew up a buy-sell agreement years ago that says if one partner dies, the other two will buy his share from his family at fair value. When one partner dies, the agreement works exactly as written, except for one problem: the surviving partners do not have the money. His widow needs the payment, the partners need the business to keep its cash, and the agreement that was supposed to prevent a crisis has become one.
A buy-sell agreement decides what happens to an owner’s share of a business when that owner dies, becomes disabled, retires or leaves. Life insurance is the most common way to make sure the money exists when the agreement is triggered.
Why the agreement matters
Without a buy-sell agreement, a deceased owner’s share passes to his estate and heirs. The surviving owners may suddenly have a spouse or adult children as partners, with a say in a business they do not run. The family, meanwhile, may own an interest it cannot sell and that pays no income. A funded agreement gives the family fair value in cash and leaves the business with the people who run it.
Cross-purchase or entity redemption
In a cross-purchase agreement, each owner buys a policy on the others and uses the proceeds to buy the deceased owner’s share directly. With two or three owners it is simple, and the surviving owners receive a higher cost basis in the shares they buy. With more owners the number of policies grows quickly, and a trust or partnership can hold them instead.
In an entity redemption agreement, the business owns one policy on each owner and buys back the deceased owner’s share. It is easier to administer, but it can have different tax effects, and the policies are company assets exposed to its creditors. The right structure depends on the number of owners, the type of entity and tax considerations, so the attorney and accountant should be part of the decision.
Valuation
The agreement should state how the business will be valued: a fixed price updated regularly, a formula or an independent appraisal at the time of the trigger. A price set years ago and never updated is one of the most common problems, because the business may now be worth far more or less than the insurance and the agreement say. The coverage amount should track the valuation, with a review at least every year or two.
Disability and retirement
Death is not the only trigger. An owner who becomes permanently disabled may need to be bought out, and disability buy-out insurance can fund that purchase over time. Retirement buyouts are usually funded from business cash flow or the cash value of permanent policies. Our article on protecting your income covers disability coverage for owners, and our article on key person life insurance covers protecting the business itself.
Keeping it working
A buy-sell agreement is only as good as its maintenance. Owners come and go, values change and policies lapse when premiums are missed during a tight year. Reviewing the agreement and the policies together keeps the promise funded.
Worth confirming on your policy
-
That your business has a written buy-sell agreement
-
That the agreement is funded with insurance that matches the current valuation
-
That the structure, cross-purchase or entity redemption, fits your ownership and taxes
-
That the valuation method is clear and the price has been updated recently
-
That disability and retirement triggers are addressed
-
That policy ownership and beneficiaries match the agreement
-
That premiums are being paid and the policies are still in force
Talk to us
Prestige Insurance Group insures Florida businesses and offers life and disability insurance to fund the agreements their owners rely on. Send us your current buy-sell agreement and business valuation, and we will work with your attorney and accountant to make sure the money will be there when the agreement is triggered.
Call the office nearest you. Se habla español.
-
Miami: 305-969-8776
-
Orlando: 407-993-2331
-
Stuart: 772-247-3788
This article is general information, not legal, tax or financial advice. Policy features, underwriting and pricing vary by carrier and change over time; review estate, tax and business planning with your attorney or accountant. Prestige Insurance Group, Florida agency license L057894.
