Life insurance buyout, or sometimes called buy-sell life insurance, is a funding method in order to satisfy a legal agreement between business partners (see our article on buy-sell agreements HERE). There are 2 components of the life buyout, the triggering event, and the funding method that provides capital. The triggering event in a life buyout is the death of a business partner and the funding method is the buy-sell life insurance owned by the other partner/s or the business entity.
Fundamentals of Buy-Sell Life Insurance Policies
The first step in purchasing a buy-sell life insurance policy is 2-fold, the legal agreement structure, and the insurance acquisition. The legal buyout (or buy-sell) agreement should be customized for each business and templates should be avoided. The reason for this is that each business and partner arrangement is different, and many legal disputes can arise if the buyout clause is exercised at the death of a partner. In addition, these agreements should be reviewed and updated at least once every couple of years to ensure that all partners are still in agreement on the language, triggering events, funding, and timeframe.
The other half of the first step is the insurance acquisition. There are 2 basic ways that insurance is structured in a buyout arrangement, either the business entity owns one policy per partner, or each partner owns one policy on every other partner. The buyout insurance market is much more complex than personally owned life insurance and anyone looking to purchase buy-sell life insurance should work with an independent broker that specializes in this area. Use caution and don’t jump right into an insurance application when it comes from a “jack of all trades” advisor/financial planner. Insurance companies have much stricter underwriting guidelines when it comes to business insurance and a specialist should be hired for this process. Look at it as a general practitioner vs. a specialist. Helm Financial is not a general practice firm, we specialize in insurance for business uses and work with clients all over the world to secure such insurance.
Does Every Business With Multiple Owners Need a Buyout Insurance Policy?
The short answer is no, not every business needs insurance to fund a buyout arrangement. A quick test to determine if you should be considering a buyout insurance policy is thinking about how you come up with the money to buy out a partner if he/she passes away suddenly. For example, if you own 1/3 of a business with two other partners and the value of your business is 6 million dollars then one of the 1/3 partners passes away suddenly. The 2 remaining partners need to either be in business with the deceased’s heirs or come up with enough capital (2 million dollars) to buy out the business interest from the heirs. Given the value of the deceased’s share is 2 million dollars, each of the remaining 2 partners needs to come up with 1 million dollars each. In general, the most efficient way to come up with the 1 million dollars is an insurance policy that pays a lump sum for the purpose of buying out the heirs. To summarize, if you cannot come up with the capital needed to buy out the shares of the deceased, you should consider purchasing insurance.
Where Do I Start?
If you have one or more partners in your business, the first step is looking at your current legal documents to determine whether or not you have a buyout agreement in place. If so, reviewing it to
ensure all partners are on the same page is a good start. If you do not have a buy-sell agreement in place, contact your corporate attorney or reach out to Helm and we will connect you with someone in our network to help. The next step is to evaluate the capital acquisition if the triggering event of death occurs. Insurance is a very efficient way to acquire the required capital and working with an independent broker who specializes in business owned insurance is the first choice to help in securing insurance. Fully or partially self-funding a buy-sell agreement is an option for capital acquisition, but the pros and cons should be weighed carefully as self-funding generally requires more cash thus reducing liquidity.
Helm Financial is an independently owned and operated insurance broker that specializes in both key person and buy-sell insurance. We have pioneered an insurance acquisition process called WayPilot that gives you the confidence you received the best deal on insurance in the marketplace.
It’s never too early to start thinking about your business’s future –– so contact us here for a quote to get started today.
This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations.