By definition, a buy-sell agreement is simply an agreement on the process of buying and selling a partnership business. Its primary role is to protect the business in case a partner dies. For context, in the event that a partner dies without such an agreement, the other partner(s) would be forced to sell assets in order to pay off the deceased partner’s family. However, with a well-crafted agreement, this would not be necessary. There are multiple ways that business can fund these agreements, and the most popular one is with life assurance. When such an agreement is funded with life insurance, the dead partner’s life insurance policy is used to buy them out. This takes care of the family, while at the same time relieving burden off the surviving partner(s). Interesting, right? So how are these agreements funded with life insurance? There are multiple ways to fund one, and here are a few of them.
- Partners can insure each other
- Company funds insurance for all partners
- Existing partners fund it after the death of a partner
This is the most popular way to fund a buy sell life insurance agreement, especially for small partnerships. Under this arrangement, partners buy each other life assurance. The amount for this life assurance is usually equal to their share of the company. Under this agreement, if a partner dies, the surviving partner becomes the beneficiary of the insurance payout, which is then used to buy out the share of the other partner. This ensures that there is a smooth transition in the business even after a partner passes on. But that’s not the only reason why it is popular. It also has tax advantages that makes it quite popular with small businesses.
This agreement is popular with large partnerships where there are more than two partners. Under this agreement, it is the company that funds life assurance for all members. It pays the premiums and is the primary beneficiary. In the event that a partner dies, it is the company that receives the payout, buys out the partner and compensates the family members of the deceased at fair value. The reason why it is popular with large firms is that, the company compensates for deficits in partners’ life assurance premiums, since they vary depending on issues like age, and health.
This is commonly referred to as a wait-and-see buy sell agreement, and entails waiting until death happens for life insurance to be funded. Under this option, when a partner dies, the life insurance of the existing partner is automatically used to purchase the dead partner’s stake, and compensate their family. This option has lots of legalities to it, and is not as popular as the other two. Nonetheless, when structured properly by a good lawyer, it is still a practical way to fund this agreement with life insurance.
In essence, the funding method that a partnership goes for is heavily dependent on the needs of the partners, as well as the number of partners in the business. For instance, for a firm with multiple partners, having the company fund it could be the best option.