As a business owner, there are several unique challenges that you will face that most people never will. One of those challenges comes in the form of life insurance. Everyone needs to have adequate life insurance coverage to protect their families, but what about the business you’ve worked so hard to grow and maintain?
If you’re a co-owner of a company, what would happen to the business if something tragic were to happen to you? That’s where buy/sell agreements can be vital.
The idea of a buy/sell agreement is to protect both partners in the business relationship if anything were to happen to either key party.
These agreements are an essential tool in the foundation of a business that can ensure the company won’t suffer drastically by the passing of a co-owner. These agreements allow the surviving owner of the business to buy out the shares that were left behind by the owner, that are now owned by the heirs.
Types of Buy/Sell Agreements Using Life Insurance Policies
There are several different types of buy/sell agreements that can be used to ensure the protection of the organization. The most common is an entity purchase agreement, which means the business busy the different insurance policies on the owners, and the premiums will be paid by the business.
The other type of buy/sell agreement is a cross purchase option, which means that the co-owners of the business buys plans on each of the other owners. With these policies, each owner pays the premiums on the other owner and is named the beneficiary of the policy. If one of the parties were to die, they would receive the payout and use it to purchase the remaining portion of the company.
There is also a wait and see buy/sell agreement, which is a combination of the two different types. It allows you to use both of the techniques to fund your agreement.
Inside of the buy/sell agreement should be strict instructions on how the heir of the remaining shares of the company should sell them to the surviving owners. The payout from the policy should only be used to accomplish exactly what is laid out in the agreement between the owners.
If you’re looking to have one of these types of agreements between yourself and your co-owners, you’ll need to determine which type of agreement fits your company’s needs. Each of them has different advantages and disadvantages. Regardless of the type that you choose, it’s vital that you have the plan in place.
Advantages of Using Life Insurance for a Buy/Sell Agreement
Every year there are thousands of business owners that pass away, which brings several complications. There are the obvious problems that the loved ones go through of losing a family member, but the businesses go through organization problems as well. With co-owners, the surviving owner now finds himself without a partner in the business and the heir now owns the other half of the organization.
For some companies, the death of a co-owner is a difficult situation, but the organization survives with few hiccups, but for other companies, it has devastating impacts, which eventually lead to the company going under. It’s better to plan for the worst when managing your organization. You never know what’s going to happen tomorrow, but you can protect yourself from any tragedies.
Disadvantages of Life Insurance for Buy/Sell Agreements
Having a plan through life insurance and a buy/sell agreement is an excellent way to secure the future of your organization, but there are some pitfalls that you and the owners should take note of. The first is that co-owners with smaller portions of the company are going to pay more for insurance on the other co-owners. For the parties that own less of the business, they have to purchase more coverage to afford to buy the remaining stocks.
Similarly, if the co-owners of the business are drastically different ages, or have varying health conditions, it can play a huge role on how much each person pays to ensure the other parties. You could find that some people are paying a lot more than the others. If you go with a policy that is funded by the company, this won’t be a problem, but a cross-purchased plan could run into drastically different premium costs for each owner.
Your premiums for the policies are going to be an additional expense that can be expensive depending on the needs of your business and the number of owners that you’re insuring. Additionally, it’s a continuous expense that you’ll have to continue to monitor.
None of the disadvantages of buy/sell agreements are major pitfalls, but you should understand all of the aspects before going into one of these deals.
What Else You Need to Know
There are several things that you need to know about life insurance to fund a buy/sell agreement for your company. The first is that these life insurance plans don’t replace the need for a personal insurance policy. This coverage should only be used to purchase remaining stock and used to fulfill the agreement. If your co-owners have insurance policies on you, your family isn’t going to see the payout from the plan, only the money from selling the shares.
You’ll want to ensure that your life insurance coverage is sufficient to purchase the ownership from the heirs. Look at the value of the company currently, and then buy a policy for that amount. It will give you enough money to purchase the full ownership or the remaining portion. If the business continues to grow, you’ll need to reevaluate your insurance needs and buy more coverage if need be.
This means that you need to still need an insurance policy on yourself to protect your family and loved ones that would suffer if you were to pass away.
Your family would be responsible for paying for any debts or final expenses that you left behind, which can make an emotional draining situation much more difficult by adding thousands of dollars in bills. Make sure that you have enough personal life insurance for your family to pay off your mortgage, any business loans, car payments, and funeral expenses.
Additionally, you’ll want to ensure that your life insurance coverage is large enough to replace your income. If you’re one of the primary income earners in your family, they would struggle to pay for necessary expenses if you passed away. Life insurance will give them the resources they need to replace your salary and not sacrifice their standard of living.
Can We Help You With Your Own Buy/Sell Agreement?
If you have any questions about life insurance for a buy/sell agreement for your organization, please contact us today. Our agents will be happy to answer those questions and ensure that your business and family have the protection that they deserve. We can help you get quality insurance at an affordable price.
One of the best ways to get the best rates on insurance for your organization is by working with an independent agent, like ours. We can compare the rates of dozens of different companies instantly.
Life insurance is one of the most important investments that you can make for both your family and your business. Because you never know what’s going to happen tomorrow, it’s vital that you always prepare for the worst.