If there are two or more parties who share ownership of a business, problems will arise if one of those parties dies or becomes disabled.
The continuing party will want to ensure that they are able to purchase the outgoing owner’s share. The outgoing party (or the estate) will also want to ensure that they are paid a fair value for the share.
In many cases it will be unsatisfactory for business succession to be determined by the outgoing party’s Will. The continuing party may not want to continue a business with a beneficiary under the outgoing owner’s Will.
Example of Problems
Here are two problems that can arise.
a. Partners you don’t want
i. A, B, and C are Partners.
ii. C dies and leaves his share in the business to D.
iii. A and B do not consider D to have any business acumen or experience and do not wish to be partners with D nor can they afford to buy out D.
iv. There may also be loan arrangements which complicate the transaction.
v. A and B take on D and the business fails because of arguments.
b. Protecting Assets/Asset Value
i. A and B are partners in an accounting firm X Co.
ii. B Dies and the executor of the estate (B’s wife) offers to sell B’s share to A.
iii. A doesn’t agree with the price and sets up another company Y Co.
iv. Y Co. over time captures most of X Co’s clients and a gets B’s share for virtually nothing.
The Solution of Insurance Funding in a Business Succession Agreement
This is where a Business Succession Agreement or Buy/Sell Agreement comes in.
Life insurance is the vehicle used to provide either all or part of the funds required to purchase an outgoing owner’s interest. The agreement contains an option to purchase in the event of the death of an owner.
A, B, and C are equal partners in a business worth $900,000.
The Business Succession Agreement gives each owner the option of buying out an owner’s share in the event of death of that owner.
If C dies, A and B can exercise their option to purchase C’s share.
Similarly, the executor of C could force A and B to buy C’s share.
That is, the Business Succession Agreement operates both ways and either party can take the first step of forcing a sale.
The life insurance policy on C would be for $300,000.
The $300,000 is paid to C’s estate in exchange for C’s shares in the Business.
If the life insurance policy on C was only for say $200,000, A and B would have to come up with the additional $100,000.
The Business Succession Agreement would allow time for A and B to come up with the extra money.
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The above is not intended as legal advice and all liability is disclaimed for reliance on it.