Just like each individual should have a Will to distribute assets according to their wishes, every business should have a shareholder agreement, also referred to as a buy-sell agreement. A buy-sell agreement provides for the transfer of ownership in case of death, disability, retirement or disagreement. This agreement will help avoid potential disruptions in the business that could arise in case a shareholder is unable or unwilling to continue their duties.
There are several methods of funding a buy-sell agreement, those include a bank loan, using the cash flow of the business or life insurance. Using life insurance to fund a buy-sell agreement is by far the most cost-effective method.
Here are the most popular methods of using life insurance to fund a buy-sell agreement:
The operating company will purchase a life insurance policy on the life of each shareholder, the company being the beneficiary. If one of the shareholders passes away (or becomes disabled), the company will receive the death benefit and is responsible for purchasing the shares of the deceased shareholder, or however the agreement is structured.
Similar to the corporate redemption method, this operating company will purchase a life insurance policy on the life of each shareholder. The promissory note stipulates that the surviving shareholder(s) must purchase the shares of the deceased person at fair market value. In this case, the company receives the insurance benefit and the proceeds are paid to the surviving shareholder(s) as a capital dividend, allowing them to fulfill the promissory note.
Not to be confused with the 80’s one-hit-wonder, the criss-cross method is when each shareholder purchases a life insurance policy on the life of the other shareholder(s), naming themselves as the beneficiary. The buy-sell agreement will require the surviving ownership to purchase the shares of a deceased shareholder from his/her estate.
In addition to being more cost-effective than borrowing the funds or utilizing the company’s cash flow, you should also consider a Universal Life policy which allows you to choose from a variety of investment options for the savings portion of the premium.
For more information on using life insurance to fund a buy-sell agreement, we encourage you to contact the insurance experts at DENT to ensure your business is protected from disruptions.
The information in this material is derived from various sources. Material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please contact us for benefit, pension and insurance advice based on your corporate or personal circumstances.