If you have a business with partners, part of your planning should be ‘what happens if one of the partners dies?’. Failure to plan for this can impact your business to the point of it being unsustainable.
By default, if you don’t do any planning, then if your partner passes away their shares and interest in the company pass to their spouse. You’re now in business with them. This is likely to lead to substantial conflict due to differences in objectives.
Surviving spouse – what they want: Cash out as quickly as they can (and your partner likely wants this for their spouse as well). What they don’t want, is long term involvement in the company.
You – what you want: the surviving spouse’s interest in the company gone so you can deal with the long term sustainability and growth of the company.
So, how do you plan around this conflict? The answer is a buy-sell agreement. You and your partners formally agree that if one of you pass away, the company will purchase their shares from their spouse. And, your partner’s spouse will agree to sell them. There’s no wiggle room left in the event your partner passes away – the company has to buy the shares, and the spouse has to sell them. Good news – this ensures that both of your competing interests are looked after. You get control of your company, and your partner’s spouse gets the cash-out value of their shares.
Everything’s good so far. The problem however, is how’s the company going to pay for this? Coming up with the cash in short order can be a huge problem. It might not be possible, and probably not possible with straight cash. One alternative would be to fund the purchase through debt. But whether that amount of funds are available as a loan is not guaranteed and even if it is, debt at that level can severely hamstring the future of a company.
The best solution is life insurance. So this is properly called a ‘life insurance funded buy-sell agreement’. The life insurance isn’t the core of the transaction, it simply is the best answer to ‘how are we going to pay for it?’.
Here’s how it works. Each partner purchases life insurance (generally term life insurance) on the other partners, in conjunction with signing a buy-sell agreement. Now if one of the partners pass away, the life insurance proceeds are almost immediately available. The surviving spouse must hand over their shares in the company, and then the life insurance proceeds are used to pay off the value of those shares to the spouse. Result? No fuss, you get control over your company, and the surviving spouse gets cashed out after their partner’s passing. Everyone achieves their best outcome.
Structure of these agreements requires three consultants – a lawyer for the agreement, an accountant to value your company and assist with structure the ownership and beneficiaries of the life insurance, and a life insurance agent to find the best policy. The life insurance agent has the least amount of input in the transaction – they basically just find a policy that’s been defined by the accountant and structures it – though they may provide some input on how that’s done.
That’s it – buy sell life insurance ensures the longevity of your company and makes sure that your spouse and your partner’s spouse is looked after in the event of one of your early demise. If you’d like a personal consultation on a buy-sell life insurance policy for your company, feel welcome to contact us.