Spokane Journal of Business

Insurance-backed buy-sell agreements key for partners

Policies are used to buy business from inheritors if one of the owner dies

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When you think of life insurance, you may think of it in its most basic fundamental form—the kind that pays off the mortgage, covers funeral expenses, and can provide income to those you love.

But what about in the business setting? That's when an insured buy-sell agreement can come into play.

An insured buy-sell agreement typically says each partner takes out a life-insurance policy on one another—or the company owns the policies—and the money is used to create the cash needed to affect a buy-out after a partner's death.

When one partner dies, the deceased's estate will agree to sell their inherited share back to the living business partner, and the partner will agree to buy it, for a predetermined, agreed-upon price. This is known as a cross purchase agreement. If the business itself agrees to buy back the stock, it is usually called a stock redemption agreement.

It keeps things tidy and makes for a smooth transition. Why is that even important? Let's look at the alternatives of not having an insured buy-sell agreement and the problems it can cause.

It may be that you have a wonderful working relationship with the family of your business partner, and that's great. But after their death, things can change, and business is business.

On the other hand, what if you love working with your business partner, but you detest the spouse? No thanks, right?

Think of whom you could be inheriting as a nightmare of a business partner. Even if the newfound partner is competent, a number of questions could arise. Will you both have the same goals for the business going forward? Will they do their fair share of the work? Do they have the same skill sets as your deceased partner? Will you be able to keep your business in the black, continue to pay yourself a salary, and still pay off your deceased partner's estate?

Of course, it could be the other way around. If you died in a car accident tomorrow, do you want your family members to be dependent upon your business partner to cut them a check each month? What if your partner goes bankrupt? What if they die or become disabled before getting your loved ones paid off? Instead of agonizing over these concerns, your partner could buy them out.

If you have the written agreement in place, is life insurance the best way to create the money? Let's examine the sources and see what you think makes the most sense.

Life insurance is best because it's purchased for pennies on the dollars and pays substantial tax-free cash. Ironically, the event that causes the problem—the death—also is the event that triggers the release of the desperately needed cash provided by the insurance. What if someone is not as insurable as someone else? Or what if there is a substantial age and cost difference between partners? In these situations, sometimes it may make sense to have a business own the policies to average out the cost and make it more fair.

A savings fund, for most, isn't plausible. If you had to, could you write a check tomorrow for 50 percent or more of the value of your business? Probably not. How much net profit after expenses and taxes would you need to save that kind of money? How long would it take?

Current income likely isn't an option either. Could you afford to run your business, remain profitable, still pay yourself a salary, and have enough money left over to pay off your deceased partner's estate? How long would that take?

Borrowing costs 100 cents on the dollar, and interest on top of that. Besides, if you were a bank, would you be comfortable loaning money to a business that just added a huge liability to its balance sheet, which may have lost one of its key players or owners, and is in risk of going out of business?

Having a well thought out, clearly written buy-sell agreement, adequately funded through life insurance for your partnership business, should be part of every successful business plan. Because this isn't your basic term policy to cover a mortgage, it's highly recommended you work with a life insurance professional versed in the implementation of life insurance used to fund these types of agreements.

  • Todd Radwick

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