When you work for someone else throughout your career estate planning can be challenging, but when you are part owner of a small business there are additional factors to consider. For one thing, if one of your partners was to pass away it is unlikely that his or her heirs will be able to step in and immediately fill that role without missing a beat.
In addition to that, even if they did want to take over and fill the shoes of the deceased partner, you and the rest of the partners may not feel comfortable with this arrangement. And in full fairness, if you were to pass away your partners would probably feel the same way about your heirs and indeed, your family members may have no interest in spending their time helping to run the business.
One of the ways that this type of small business succession situation is handled is through the use of buy-sell agreements. There are two approaches that are most typically used, and the first one we will touch upon is the cross purchase plan. The way this works is that the partners decide on the value of each ownership share. They then take out life insurance policies on one another in an amount equal to each partner’s share, the total of which equals the total agreed upon value of the business. An agreement is drawn up stipulating that upon the death of one of the owners the remaining partners will buy out his or her share from the heirs of the deceased with the proceeds from the life insurance policies.
The other type of buy-sell agreement that is often used is the entity purchase plan. With this approach the business itself purchases life insurance on each partner in an amount that is based on an agreed-upon valuation of the ownership shares. When one of them passes away the business uses the life insurance benefits to purchase the ownership share of the deceased partner from his or her family.