Business Insurance Center

Business Insurance Q & As

Question 46 of 61 in Basics
Buy sell agreements and business insurance after the loss of a partner

Nothing can be more devastating to a business then unexpectedly losing a key contributor due to death or disability. One way a business can minimize the damage from losing a partner is through a buy sell agreement. Understanding how to use these buy sell agreement and having yours reviewed by an expert attorney knowledgeable of these types of contracts is best way to get the best results from these documents.

What is a Buy and Sell Agreement?

A buy sell agreement is a legal document that binds business partners to buy out the interest of a deceased partner at terms and price that are predetermined so as to allow the business to continue to be run by the remaining partners. Most businesses use key person life insurance to fund the buyout of the deceased partner's share. The business will pay the premiums and the death benefit is used to fund the buy sell agreement transaction.

It is important that any buy sell agreement be carefully drafted by attorneys experienced in how to meet the exact requirements of the organization. If you are prepared to write a contract without an attorney, there are buy sell agreement templates that you can use, but make sure that you do not under estimate the need for a business attorney that can review your agreement for any legal problems that could arise.

Similar arrangements may protect against long term disabilities. An unexpected disability can sideline a main player in a business. A buy sell agreement funded by a disability policy can provide needed funds in the event of such an incident and buy out interests of someone who will not be able to return to the business for a long period of time. Disability income protection can also contribute to paying overhead expenses when an owner is incapacitated.

Buy Sell Agreements in Closely Held Corporations

The death of a shareholder of a closely held corporation does not terminate the corporation, but it may have serious consequences concerning the continuation of the business and the disposition of the deceased shareholder's stock (including the possibility of unwanted heirs or outsiders acquiring the stock and becoming involved in the business).

The sale of the deceased owners stock could become effective immediately upon death. Again, the solution here could be a properly designed and executed buy-sell agreement. The buy sell agreement should reflect the goals of the people making the agreement clearly and in great detail. Some agreements require the other shareholders to purchase the stock of the deceased shareholder at the time of death. For closely held corporations where stock an issue, you could also design a stock redemption plan.

What Is a Stock Redemption Plan?

A stock redemption plan effectively is a buy sell agreement that stipulates the cash sale of the stock of a deceased shareholder or owner. The corporation buys and redeems (holding as treasury shares) the shares of the deceased shareholder. A shareholder may wish to receive cash for his or her stock in a closely held corporation in order to retire or for other reasons. In this case, cash value life insurance can be used to fund a buy/sell agreement to be carried out at the time of retirement of an owner. A similar situation can arise when extended period of disability render an owner unable to continue with the business and thus trigger an agreement to redeem the stock of the affected stockholder. Buy sell agreements plans for contingencies such as this can be established with funding coming from disability insurance or life insurance policies.

Determining Value of the Business for Buy-Sell Agreements

Executing a buy sell agreement or other contingency transaction plans requires a predetermined estimation of the value of the business. It is essential that a valid method for determining an accurate value be used. The buy sell agreement may have been draw up long before the time that the value of your business is needed. However, when a triggering event puts the buy sell agreement in action, the most accurate value of your business will be needed.

Employing the services of a CPA or a business valuation analyst is the best way to get the most accurate value of your business. There are sever methods they can sue and knowing which would know which method is best for your type business. Determining the value of a small business can be less complicated. There are online business value calculators that can walk you through determining a value for your small business.

What a Buy Sell Agreement Must Include

An effective buy sell agreement needs to include the following factors:

  • What events will trigger the buy sell agreement (death, retirement, disability)
  • How will the buy sell agreement be funded (life insurance, cash, disability insurance, etc)
  • How the valuation of your business will be determined and by whom

Creating such an important document should be done with the legal advice of an attorney. A buy sell agreement can salvage a business after the loss of a key partner, so make sure to take the time and build a proper contract.