Business is not just a business. It is also a lifeline to the people who are depending on it – the owners and their family members, as well as the employees and their families. For this reason, keeping a business alive should be an essential part of the business plan. In this case, business planning should always consider insurance.
Every business across the globe runs the risk of failure. This includes business in the 2016 America’s top state for business: Utah. Though Salt Lake City is a big part of Utah’s success, it’s no reason for business owners to get too self-assured. Some key executives leave for many reasons that can cause a business to collapse. They may be disabled, severely ill, or worse, die. Most companies do not fund contingent business liabilities. The owner and the business are not insured when such circumstances happen. That is why having a Buy-Sell agreement in life insurance is very essential.
What is a Buy-Sell Agreement in Life Insurance?
Buy-Sell Agreement in Life Insurance is designed to a protect the business, owners and family members if one of the owners passes away. Also, it determines the business’ equity if unfortunate events happen. It is commonly used by established businesses with two or more owners. This agreement keeps the continuity of business for the remaining owner(s) by buying the deceased owner’s share from their family. Through a Buy-Sell life insurance agreement, every co-owner of the business purchases a life insurance policy. This provides a death benefit that is equal to their ownership share in their business.
Having no Buy-Sell life insurance agreements can be a threat for businesses resulting in the extreme consequence of needing to close the business. Most often, there is liquidation to reimburse the deceased owner’s family for their business shares.
A Buy-Sell Agreement in Life Insurance provides you with a peace of mind. You can be sure that your dependent family members will have the support they need to work out details with your business partners.
How to establish a Buy-Sell Agreement in Life Insurance?
1. Determine the value of your business
There are three common accepted methods in calculating your business’ value, namely: Book Value, Market Value, and Capitalization of Earnings.
- Book Value – it is the business’ net worth. It is calculated by summing up all the company’s assets minus its liabilities.
- Market value – it is the value that buyers are offering to pay for your business. It is referred to as ‘good will’ if your business’ market value is higher than its book value. Most insurers also offer you a higher amount if your business has a high market value.
- Capitalization of Earnings – It is calculated by getting the average of the previous year’s net revenue. If your business is new in, the estimate will rely on future earnings.
2. Calculate each owner’s share
After determining the value of your business, you need to calculate the worth of each business owner’s share. If each business owners have an equal share, just divide the value of the business over the number of owners. However, if each owner owns a different amount of shares, you need to multiply their business share percentage to the total value of the business.
For example, XYZ Company is worth $3,000,000 and has three business owners. X owns 20%, Y owns 35%, and Z owns 45% of the business.
- Owner X: 20% x $3,000,000 = $600,000
- Owner Y: 35% x $3,000,000 = $1, 050,000
- Owner Z: 45% x $3,000,000 = $1,350,000
After determining each business share’s worth, each owner should apply for a life insurance policy with a death benefit. It should be equal to their share of the business. It is also referred to as entity purchase, stock purchase, cross purchase, partnership insurance, or stock redemption.
The type of Buy and Sell agreement you need depends on your business structure and number of business owners.
- Cross Purchase Buy-Sell Agreement
You can establish this Buy-Sell Agreement in Life Insurance if your business has two owners. With this agreement, you are buying life insurance for your business partner. Likewise, they are purchasing a life policy insurance for you. Both of you will be the payor and beneficiary of each other’s life insurance policy.
- Stock Redemption Buy-Sell Agreement
This is suitable for businesses with two or more owners. With this buy-sell agreement, the business itself is listed as the payor and owner of each partner’s life insurance policy. If unfortunately, one owner dies, the corporation will collect the death benefit from their life insurance policy.
- Utilize all the necessary information
There are certain requirements needed when applying for a fund to your Buy-Sell agreement in life insurance. Some business owners apply for a 10-year term, but it can also be extended for a longer term if needed.
Aside from the length of the term and amount of coverage needed, the following are the requirements for each owner’s application:
Personal information – name, date of birth. Also, the ownership share of the business.
- The approximate value of the business, and its calculations
- Copy of the company’s buy-sell agreement from your attorney
- Overview of the business and some documents that will support your business value
- Business address, taxpayer ID, and any additional documents that can provide financial insight about your business
Once the application is completed and approved, the insurance company will secure a copy of each insurance policy for safekeeping. Also, a copy will be mailed to your business.
What are the advantages of having a Buy-Sell Agreement in Life Insurance?
1. Business continuity is assured even if one owner dies. This provides remaining owners with cash to purchase deceased owner’s shares.
2. In case of death, it will provide income for the deceased owner’s family.
3. It prevents the deceased owner’s family members from becoming business partners.
4. Death benefit from life insurance is typically tax-free.
5. It enhances credit risk. This is because a succession plan is in place.
Buy-Sell Agreements in Life Insurance is one component of the process of business planning. The idea behind this is to ensure all the business owners have the right protection for their hard work. As many people rely on it, it can be crucial to consider having this kind of agreement. This is beneficial not only to the owners but also, to their heirs.
Life can be unpredictable. You will never know when it will throw a stone that mbe life-ending. Being insured will not only protect your business, but it will also help your surviving family members from further loss.