What is Buy-Sell Insurance?

December 2nd, 2011 | Author: Mitch Reynolds

There is no such thing as buy-sell insurance

Life and Health Insurance to Fund a Buy-Sell Agreement

Buy-Sell Insurance - Buy-Sell Agreements If you have ever heard of buy-sell insurance and wondered what it is, then you’ll just have to keep on wondering because there actually is no such thing as buy-sell insurance. There is a Buy-Sell Agreement (also called a U.S.A. or Universal Services Agreement) which is a legal document spelling out the rights of ownership between business partners and shareholders in the event of a death or disability of one of the owners of the business.

A Buy-Sell Agreement is designed to fairly compensate the estate and heirs of the deceased business owner or to fairly buy-out their shares or partnership stake in the event of a long-term disability. If a business is a partnership or has multiple primary shareholders (privately held corporation) and there is no buy-sell agreement in place then the shares they own in the business or their partnership stake passes through the deceased’s will to their heirs – usually a spouse or children.

If you have business partners and DON’T have a buy-sell agreement in place you might end up being in business with your partner’s spouse or children.

How Life Insurance Fits Into a Buy-Sell Agreement

Life insurance is usually the lowest cost way to guarantee funding for a buy-sell agreement should the business need to buy-out the shares of a deceased owner. The economy is cyclical and we never know how well the business is doing in the future. Will the business have the money on hand to buy-out the shares or partnership stake if one of the owners dies?

Even if the economy is going well, the owners might have recently invested a lot of retained earnings and even gone into debt for a business expansion. Tragedy can strike at any time, and the business needs to be ready.

Here are some options to generate capital to fund a buy-sell agreement:

Use retained earnings if there is enough cash on hand. This will reduce the share value of the company as cash leaves it’s account and might postpone investment opportunities that money was set aside for.
The business could borrow funds to pay-out the estate of a deceased owner. This will add financial pressure to the business and reduce cash flow and gross earnings of the business.
The business could sell assets to raise capital. This might be OK if there are assets that are not being used, but selling useful business assets will reduce the company’s long-term earning and growth potential.
Use tax free proceeds from a life insurance policy to fund the agreement. The cost of life insurance can be very low, often a fraction of a cent on the dollar annually to guarantee that funds would be available if and when they were needed. This strategy would have a very minor impact the company’s annual cash flow and provide substantial financial security for all business owners and their families.

How Disability Insurance Can Be Used For a Buy-Sell Agreement

There are some specialized disability insurance policies that would provide a large amount of tax free cash to the business in the event a business owner (who is usually a manager and key person to the business) is suffering from a long-term disability. This specialized disability insurance contract will not pay a monthly income, and will in fact pay nothing for the first 12 to 24 months that the business owner is away from the company due to a serious illness or injury.

If, after a pre-determined amount of time (minimum 12 month – maximum 24 months), the owner is not able to return to the business, being still totally disabled, the business would receive a large amount of tax free cash from the disability insurance policy.

It might be important to partners/owners of a business that they would have the opportunity to buy-out one-another if any of them was sick or injured and no longer able to contribute to the business.

A disabled partner/owner would still be receiving income or dividends from the business even though they are no longer contributing to its success. Most business partners could only tolerate this situation for so long before they would want to move that person out of the business. The disability insurance buy-sell policy would give them the funds to exercise such a buy-out clause put in their buy-sell agreement.

Without a disability buy-sell insurance policy and a buy-sell agreement specifying a living buy-out of a partner/owner then the active owners would have to negotiate a buy-out of the disabled partner/owner. Terms might not be so favourable for the active partners. While everyone is healthy and active in the business a rational and fair settlement of a living buy-out can be negotiated between partners and written into a buy-sell agreement. Then disability buy-sell insurance can be purchased to help fund the buy-out in case it is needed in the future.

Buy-Sell Insurance – Funding a Buy-Sell Agreement

So, in conclusion, a buy-sell agreement is a legal document drawn up between business partners or shareholders to determine how the company deals with a death or long-term disability of an owner. It protects the interests of the owners’ families so they are fairly compensated for his/her value in the business and keeps ownership and control in the hands of the remaining shareholders or partners.

A life insurance policy is the primary funding tool for a buy-sell agreement and is often referred to as buy-sell insurance. In fact it is just a plain old life insurance policy (often term life insurance) being used for the specific purpose of fund the agreement if an owner dies. Death is a pivotal event! By law the affairs of the deceased are wound up and assets pass to his/her heirs. Without a buy-sell agreement in place the business assets will pass to the next of kin (spouse or children) and suddenly the business has a new owner who might not know anything about the business.

Planning for a long-term disability is less problematic. The owner is still alive and all the business owners can negotiate a settlement. Sometimes it makes sense to have a disability buy-sell insurance policy, and at other times it doesn’t. It all depends on what type of business you’re in and if cash flows can support a disabled owner and eventually buy them out.

Life Guard Insurance can help fund your buy-sell agreement

Contact Life Guard Insurance to speak with an experience life insurance broker in your area. We have brokers across Canada who are experienced with complex life insurance policies like buy-sell life insurance funding to help you.

The article was written by +Mitch Reynolds. If you found this article interesting or it made you think, please feel free to share your comments below. Liking us on Facebook, giving us a +1 on Google or Tweeting this article about buy-sell insurance would also be very much appreciated.