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Business Planning with Buy/Sell Agreements and Life Insurance

March 21, 2012

Succession planning is often overlooked by small businesses, It is important because the loss of an owner or key partner can cause rapid economic loss and in some cases affects the ongoing viability of the operation.

It is relatively easy to infer the purpose of most insurance products just through the name. As an example, pollution liability is exactly what it sounds like and there is never any confusion about workers compensation. Now consider the term “Buy/Sell Agreement”. It sounds like it should be an agreement to buy and sell different companies. It is not. A Buy/Sell agreement is a succession tool that contractually defines how the business is transferred to other partners, owners, or legally interested parties.

A frequent Buy/Sell trigger event is the death of a partner which may necessitate the sale of the business. A common way to fund this purchase is through life insurance, for which there are two options: an Entity Plan or a Cross Purchase Plan.

Entity Plan — The business entity purchases a life insurance policy on each partner. It pays the premium payments and is the beneficiary of the policies. When a partner dies, his/her interest is purchased from the estate by the business entity. That interest is then divided according to the Buy/Sell agreement.

Cross Purchase Plan — Each partner buys a life insurance policy on every other partner in the business. Each partner owns, pays the premium payments and is the beneficiary of the insurance policies on the other partners. When a partner dies, the proceeds are used to purchase the partner’s business interest from the heir’s of the deceased.

When developing a business succession plan, there are several advantages to using Life Insurance as a vehicle to fund Buy/Sell Agreements. These funding strategies may also address disability or retirement of a co-owner or partner. For businesses with a wider variety of ownership percentages different funding and succession approaches should be considered.

Note, neither Avanti Services, nor its affiliates or representatives provide legal or tax advice. Please consult your tax advisor and/or your attorney for tax planning and/or legal counsel.

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