Funding a Buy-Sell Agreement with Life Insurance
Businesses that are owned by a group of individuals should consider the financial consequences if any one of its significant stockholders should suffer a premature death. One consequence is that the survivors of the deceased owner are now the stockholders. This “new” stockholder may be disinterested in the business, yet still hold all the stock, and is entitled to all the dividends and voting power, of the now-deceased owner.
You should therefore consider setting up a buy-sell agreement with your partners or co-owners to ensure the smooth transition of your business interest in a case such as this. Of course setting up a Buy-Sell - and being able to pay the dead stockholder’s family their fair share, in cash, are two different things! Therefore you must also investigate funding methods.
One of the first methods to consider is life insurance. The life insurance that funds the buy-sell agreement will create a sum of money at death that will be used to pay the survivors’ family or estate for the full value of the ownership interest.
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). At death, the policy owners (the company or co-owners) receive the death benefits from the policies. That money is paid to surviving family members as payment for the interest in the business. Survivors get a sum of cash they can use to help sustain themselves, and the company has ensured its continuity and ownership stability.
The buy-sell agreement should be fully funded
The amount of insurance coverage should equal the value of each ownership interest. Then there will be enough cash from the policy proceeds to pay the surviving family or estate in full for each share of the business.
