BUSINESS CONTINUATION (BUY-SELL) INSURANCE
One reason a business might suffer or even fail is due to the sudden inability of the owner(s) to perform the many duties necessary to keep it going. This can be because the owner suddenly becomes disabled, or even worse, passes away. If there is more than one owner, the remaining owner(s) is now faced with the possibility of having the disabled or deceased owner’s heirs (often the spouse) as a new business partner. Most of the time this is unacceptable to both parties. Usually the spouse has neither the qualifications or desire to help run the business, and the remaining owner(s) may not be thrilled about having her/him as a partner.
The way around this potentially messy situation is to have a well-designed and written buy-sell agreement in place BEFORE an owner dies or becomes disabled. Such an agreement will spell out the terms in which the remaining working owner(s) would buy out the spouse’s interest in the business. This will ensure that the spouse is compensated for her/his share of the business and that the remaining owner(s) can continue running the business with as little interruption as possible. This can also be done when there is only one owner. An agreement can be put in place to sell the business to an employee or group of employees, or even to a competitor.
However, a buy-sell agreement of any kind is only effective if there is sufficient funding to make it work. Often, a remaining owner will not have the money needed to buy out a surviving spouse of a partner. This is where insurance comes into play. A properly designed life insurance policy on each owner, with the other owner(s) listed as beneficiaries, will ensure that the funding is there when it is needed. Disability buy-out policies can also be used for when an owner is no longer able to work due to a serious illness or injury.
One way of setting up these policies is with a cross purchase agreement. With this arrangement, each owner buys a policy on the other owner’s life and is the beneficiary of that policy. The amount of the policy should be for each owner’s interest in the company. In the case of a single owner, the other party (another employee(s) or a competitor) would buy a policy on the owner and would be the beneficiary. Upon the owner’s death, the beneficiary uses the insurance proceeds to buy out the surviving spouse (or heir). A cross purchase agreement is usually used when there are two owners.
Another option is to use an entity agreement when there are three or more owners. This is when the company is the owner, purchaser and beneficiary of a policy on each of the owners. Upon the death of an owner, the insurance proceeds go to the company and are then paid to the surviving spouse. The reason this is used with multiple owners (rather than a cross purchase agreement) is due to the complexity of multiple policies being needed when there are three or more owners. For example, if there are three owners, six policies would need to be purchased in a cross-sell agreement, whereas only three need to be purchased in an entity agreement.
This type of planning should be done as early as possible since time only works against one’s ability to qualify medically for this type of insurance.