One common question we receive when discussing key person benefits is “What is a buy/sell agreement?” A buy/sell agreement, also known as a buyout agreement, is a contract funded by a life insurance policy that can help minimize the turmoil caused by the sudden departure, disability or death of a business owner or partner.
Types of buy/sell agreements
Many business owners choose one of two buy/sell agreement life insurance plans. They include:
A cross purchase plan – A cross purchase agreement depends on each business owner buying a life insurance policy on each of the other owners. Then, when an owner dies, the remaining owners use the payout from the life insurance policy to buy the deceased owner’s share of the business.
An entity purchase, or stock redemption, plan – Each employee-owner enters into an agreement with the business to sell their interest in the business. As part of the agreement, the business buys life insurance policies on the lives of each owner. The business pays the premiums and therefore exists as the owner and beneficiary of the policy. When an employee-owner dies, that share of the company passes to the heirs of his or her estate. Then the business can use the policy’s death benefit to buy the interest from the estate.
Potential business benefits of a buy/sell agreement
A buy/sell agreement gives employers peace of mind knowing that their business is in capable hands should they no longer be able or want to manage it. It also:
Provides money to create a fair market value exchange
Promotes equitable and orderly transfer of wealth, ownership and management
May offer tax advantages
Guarantees heirs a buyer for assets they may not know how to manage
Provides heirs cash to pay estate debt, expenses and taxes
Potential benefits for business partners and employees
For employees, a buy/sell agreement provides a way to purchase a business they have a vested interest in but may not have the capital for. It also:
Assures remaining owners that the deceased’s share of the business will not pass on to someone unsuitable
Assures continuity for customers, creditors and employees
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