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Business Uses
Key Persons
What is Key Person Life Insurance?
How do you set up a Key Person Life Insurance Policy?
Business Continuation
What is a Buy/Sell Agreement?
How does a Buy/Sell Agreement funded by life insurance
work?
Sole Proprietorship
Partnership
Corporation
Business Uses
- Key Person - A life insurance policy can be used to protect
a business from the loss of income and profits caused by the death
of a key employee.
- Business Continuation - Life insurance can be used to fund
a Buy/Sell Agreement or stock redemption plan to enable a partner
or group of employees to buy the business interest of a deceased
partner.
- Business Loans - Life insurance protection on a key employee
or business owner can be used to pay off the debts of a business
in the event of that individual's death.
- Employee Benefits - Life insurance protection for employees
is commonly included in company employee benefits plans.
Key Person
What is Key Person Life Insurance?
Maybe your business is operated primarily by one person or maybe
your company is run by a small team of executives whose expertise
is the lifeline of your business. The premature death of a key person
could signal the premature death of the business. With a Key Person
Life Insurance Policy, a business can increase the chances of survival
if it were to lose a key member of the organization.
- cover business debt
- leave working capital for a surviving partner(s) to continue
the business
- identify and hire a replacement for the Key Person
- provide cash for the business in case there is a major revenue
shortfall because of the loss of the Key Person
How do you set up a Key Person Life Insurance
Policy?
The first factor to consider in setting up a Key Person Life
Insurance Policy is to determine how much death benefit is needed.
The minimum usually considered is one times the key persons annual
income, but other factors need to be considered. What if the business
relationships of this person drive half of the companys revenues?
How difficult and costly will finding a replacement be? Are there
business debts that would place financial hardship on the company?
Once the death benefit amount has been determined, the business
would purchase the policy on the key person. The key person would
be the insured and the business would be the owner, payor and beneficiary
of the policy. Permanent or term life insurance can be used as a
key person policy depending on the needs of the business and how
much they are willing to spend.
Business Continuation
What is a Buy/Sell Agreement?
A Buy/Sell Agreement is a contractual agreement that provides
for the continuation of a business in the event of the death or
disability of a sole proprietor, partner or shareholder. An agreement
may stipulate that, upon the death of a shareholder or partner of
a company, the company or other partners buy back the deceased's
interest in the business. Life insurance is commonly used to fund
Buy/Sell Agreements because it provides both liquidity and tax advantages
in funding the transaction.
The following are important reasons to use a funded Buy/Sell Agreement:
- Liquidity-A funded Buy/Sell Agreement creates a market instantly
for the deceased's share of the business. Otherwise, if a funded
Buy/Sell Agreement were not in place, the purchase of the deceased's
stake in the business would have to come out of the company's
working capital (if there was enough to fund the purchase). In
addition, if an outside party were to purchase the deceaseds share,
the timing of the transaction could result in a lower valuation
of the company because of the death of a key owner and the fact
that the deceased's family wants to sell in a potentially soft
market.
- Transition of Business-A funded Buy/Sell Agreement assists
in the efficient preservation and transition of the control and
management of the business.
- Estate Planning-A funded Buy/Sell Agreement can provide cash
for potential estate taxes and settlement costs and establish
a valuation of the deceased's business interest for estate tax
purposes.
- Cost-A funded Buy/Sell Agreement funded with life insurance
can be inexpensive (the cost for the purchase of a business is
essentially the premiums paid for the life insurance policy).
Life insurance provides a simple way to administer a funding vehicle
for the purchase of the deceased's ownership according to the terms
of the Buy/Sell Agreement. The business also protects itself from
any future drain on working capital, damage to its credit position
and/or the legal or financial problems that could arise out of the
company's inability to fund the Buy/Sell Agreement with its own
income.
How does a Buy/Sell Agreement funded by life
insurance work?
Buy/Sell Agreements may be set up in conjunction with Sole
Proprietorships, Partnerships, and Corporations. The method for
each is a little different. Below you will find a general description
of the options available for each type of business.
Sole Proprietorship
If a sole proprietor has a key employee that has the desire to purchase
the business in the event of the sole proprietor's death, a Buy/Sell
Agreement can facilitate the key employee's purchase of the deceased's
business. The sole proprietor and the key employee would enter into
a Buy/Sell Agreement, and the key employee would purchase a life
insurance policy on the life of the sole proprietor. Pursuant to
the Buy/Sell Agreement, upon the death of the sole proprietor, the
key employee uses the death benefit to purchase the sole proprietor's
business from his estate.
Partnership
Cross-Purchase Method
The Cross Purchase Method of entering into a Buy/Sell Agreement
works best if there are a small group of partners (preferably two).
The partners enter into a Buy/Sell Agreement and each partner buys
a life insurance policy on each of the other partners lives. Pursuant
to the agreement, upon the death of one of the partners, the surviving
partners use the death benefit from the above-mentioned policies
to buy the deceased partner's business interest from his or her
estate. The surviving partners then own all of the partnership while
the deceased partner's estate receives the funds from the sale of
the deceased partner's share of the partnership.
Entity Method
The Entity Method of entering into a Buy/Sell Agreement offers
the advantage of simplicity over the Cross-Purchase Method if there
are more than two partners or if there is a likelihood of more partners
joining the business later. In this scenario, the partnership and
each partner enter into a Buy/Sell Agreement. The partnership buys
a life insurance policy on each of the partners lives. Pursuant
to the Buy/Sell Agreement, upon the death of one of the partners,
the partnership uses the death benefit from the above-mentioned
policy to purchase the deceased partner's business interest from
his or her estate. The surviving partner's then own all of the partnership
while the deceased partner's estate receives the funds from the
sale of the deceased partner's share of the partnership.
Corporation
Cross-Purchase Method
The Cross-Purchase Method of entering into a Buy/Sell Agreement
works best if there are a small group of shareholders (preferably
two). The shareholders enter into a Buy/Sell Agreement and each
shareholder buys a life insurance policy on each of the other shareholders
lives. Pursuant to the Buy/Sell Agreement, upon the death of one
of the shareholders, the surviving shareholders use the death benefit
from the above-mentioned policies to buy the deceaseds shareholder's
business interest from his or her estate. The surviving shareholders
will own all of the outstanding corporate stock while the deceased
shareholder's estate receives the funds from the sale of the deceased
shareholder's stocks.
Stock Redemption Method
The Stock Redemption Method of entering into a Buy/Sell Agreement
offers the advantage of simplicity over the Cross-Purchase Method
if the corporation has more than two shareholders or if there is
a likelihood that additional shareholders will join the business
later. In this scenario, the corporation and each shareholder enter
into a Buy/Sell Agreement, and the corporation buys a life insurance
policy on each of the shareholder's lives. Pursuant to the Buy/Sell
Agreement, upon the death of one of the shareholders, the corporation
uses the death benefit from the above-mentioned policy to purchase
the deceased shareholder's business interest from his or her estate.
The surviving shareholders then own all the outstanding corporate
stock while the deceased shareholder's estate receives the funds
from the sale of the deceased shareholder's stock.
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