22 October 2013 0 Comments

Binding A Business Agreement

a firm handshakeIn my last entry I discussed the importance of business owners entering into an agreement to sell their business interests in the event of death.  It is so important to enter into a buy-and-sell, or stock redemption agreement prior to death.  The agreement should require that the heirs of the deceased business owner sell and that the survivor(s) buy. The price, or a formula for determining the price, should be a part of the agreement.  The surviving buyer(s) could be the partners of the deceased or a family member or other outside party.

Life Insurance becomes the most obvious financial instrument to complete the funding for this transaction.  The event that creates the need—death—produces the cash.  Depending on the type of agreement, either the surviving partners or the business entity own the life insurance policy, receive the proceeds and use them to purchase the business interest from the estate of the deceased.  If the insurance proceeds fall short of the full buy-out amount, the balance is settled by a note.

Whether term or permanent insurance should be used to fund this agreement depends on the age of the owners, and the anticipated duration of the current business entity.  If the plan is to sell the business, or to go public, within a limited period of time, then term will probably work.

The premium paid for life insurance used to fund a buy and sell or stock redemption agreement is not tax deductible.  That’s because it is not considered a normal cost associated with conducting a business and the proceeds are received tax free.

When partners in a business are not close in age or the medical history of one partner causes a discrepancy in premiums, the partner whose premium is less, often complains that it is not fair that they bear the higher premium cost for the other partner.  Of course that answer to this is obvious.  The likelihood of their receiving the proceeds to buy out their partner is much greater than the reverse.

If you own or co-own your own business or profession it is imperative that you have a business succession plan.  Discuss this matter with your attorney and involve an insurance agent to provide the funding.

Next, I’ll be revealing some real life misunderstandings of what life insurance will cost.

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