BUY SELL AGREEMENT FUNDING AMOUNTS:

How do you determine how much life insurance and what kind of life insurance to get for a buy sell agreement on the company you own?

 

When setting up a buy-sell agreement for your business, determining the amount of life insurance and the type of policy to secure is a critical decision. A well-structured buy-sell agreement, often funded by life insurance, helps ensure a smooth transition of ownership in the event of a partner's death or departure. Here are steps to help you determine the right amount and type of life insurance for your buy-sell agreement:
 

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1. Business Valuation: First, you need to determine the current value of your business. This valuation serves as the basis for the life insurance coverage. You can hire a professional appraiser or work with your partners to agree on a valuation method.
 

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2. Identify Key Participants: Identify the key participants or co-owners in the business who would be affected by the death of a partner. These individuals are the ones for whom you'll secure life insurance.
 

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3. Type of Life Insurance:

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a. Cross-Purchase Agreement: In a cross-purchase agreement, each partner buys a life insurance policy on the lives of the other partners. This means multiple policies are involved, and each partner is the beneficiary of the policy they own. This type is usually more suitable for businesses with a limited number of partners.

 

b. Entity-Purchase (Stock Redemption) Agreement: In an entity-purchase agreement, the business entity itself purchases life insurance policies on the lives of each partner. The business becomes the beneficiary of these policies, and in the event of a partner's death, the business uses the insurance proceeds to buy out the deceased partner's interest.

 

 

 

4. Calculate the Coverage Amount:

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a. For a Cross-Purchase Agreement: Determine the amount each partner's interest is worth in the business. Each partner purchases a life insurance policy on the others for this amount. The policy payout will be used to buy the deceased partner's interest from their heirs.

b. For an Entity-Purchase Agreement: The business entity takes out policies on each partner, typically in an amount that reflects the partner's ownership share. This allows the business to buy the deceased partner's share from their heirs, maintaining ownership within the business.

 

 

 

5. Review and Update Periodically: It's crucial to periodically review and update the insurance coverage. As the business's value changes or as partners' interests change, the coverage amount may need to be adjusted.

 

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6. Work with an Insurance Professional: Consult with an experienced insurance professional or financial advisor who specializes in business succession planning. They can help you navigate the complexities of buy-sell agreements and select the most appropriate life insurance policies.

 

 

 

7. Legal Counsel: Lastly, work with an attorney who specializes in business and estate planning to draft the buy-sell agreement. Ensure that the legal document aligns with the insurance policies and the business's structure.

Keep in mind that the specifics of your buy-sell agreement and the insurance requirements may vary depending on your business's structure (e.g., partnership, LLC, corporation) and the unique needs and goals of the partners involved. It's crucial to have a comprehensive and well-drafted agreement to protect the business and all stakeholders in case of unforeseen events.