What does it mean to fund a buy-sell agreement with life insurance? It's not too different from the general purpose of life insurance. As you probably know, life insurance creates a sum of money payable at the death of the insured person. That money is intended to offset the financial burden created by the insured person's death. When used to fund a buy-sell agreement, that money goes to the deceased's business partner(s), who then use the cash to buy the deceased's share of the business interest from his or her family or estate.
Using life insurance in a buy-sell agreement requires all the same procedures involved in buying personal life insurance. You have to complete an application (including your medical history) and take a brief life insurance medical exam for underwriting purposes. Here are three key points to keep in mind:
1. You Must Be Insurable
For life insurance to fund your buy-sell agreement, you have to be able to get life insurance, which usually involves a medical exam. If you're in poor health, you might be considered uninsurable by the insurance companies. Even if some of the parties who co-own your business are uninsurable, you can still use insurance with your buy-sell agreement. You'll just need to structure alternate financing for the uninsurable shareholders.
2. You Must Be Specified in the Buy-Sell Agreement
You can use life insurance funding if you are one of the parties specified in a buy-sell agreement and are obligated by the terms of the agreement to purchase all or a part of the business interest held by another buy-sell participant at their death. This obligation provides an insurable interest, one of the requirements for an insurance company to issue a policy. In other words, the money can't go to someone who isn't a partner.
3. You Must Make Payments to Own the Policy
Although it's not an ironclad rule, the partners, partnership, stockholders, or corporation (whoever is the purchaser specified in the agreement) usually pays the premiums. The party paying the premiums is also generally the owner of the policy. This means they receive the death benefit when the insured passes away, with the intention for them to buy the deceased person's share of the business.
To see how important it is to protect your business and ensure its longevity, check out the video below.
A buy-sell agreement is at the heart of every sound business continuation strategy. If you don't have one yet, I can help you insure yourself, your partners, and anyone else integral to your business.