When you are a partner in a small business, you are naturally going to have some estate planning concerns. Your share in the business may be quite valuable, and you may want to distribute the value of the business among multiple different heirs.
How are you going to obtain the necessary liquidity? Your family could sell the business to the highest bidder after you pass away, but where would this leave the surviving partners? They may not be comfortable with the purchaser, and you may feel the same way if one of your partners was to predecease you.
This type of situation can be handled through the creation of a business continuation agreement called a buy-sell agreement.
Cross Purchase Plan
One type of buy-sell agreement is called the cross purchase plan. The first order of business will be to convene the partners in the business. You mutually agree upon the value of a share in the business. Once this has been established, each co-owner takes out an insurance policy on the life of every other partner.
The sum total of the policy proceeds will be calculated to equal the value of an ownership share of the business. When one of the partners dies, the other partners will collect the insurance policy proceeds. The money is then used to purchase the share that was owned by the decedent.
The decedent’s family would then be in possession of liquidity that could be distributed among multiple heirs according to the wishes of the deceased partner. Meanwhile, the surviving partners could continue to run the business as usual.
Entity Purchase Plan
There is another type of buy-sell agreement called the entity purchase or stock redemption plan. This type of business continuation agreement also involves the purchase of life insurance. However, the co-owners do not individually purchase life insurance policies on one another.
With the entity purchase plan, the business itself takes out life insurance policies equal to the value of the shares that are held by each respective co-owner of the business. When one of the stakeholders passes away, the business will receive the proceeds from the insurance policy on that partner’s life. These proceeds will be used to buy the share that was owned by the deceased partner from his or her estate.
Free Business Planning Consultation
A buy-sell agreement can be part of the equation when you are planning your estate as a small business partner. We have just scratched the surface in this post. If you would like to learn about business succession planning in-depth, contact us to schedule a free consultation.
At the consultation we will gain an understanding of your situation, answer all of your questions, and help you put a comprehensive estate plan in place.
Parman & Easterday