Succession planning for small business partners can often be facilitated with a buy sell agreement. The best way to explain the value of this type of an agreement is to provide a simple example. Let’s say that you have one business partner, and the business has been successful over the years. Your share in the business is your most valuable asset.
What would happen in the event of the death of you or your partner? If you were to predecease the co-owner, your heir or heirs would own your share of the business. This could put your partner in a difficult situation, and you would also be negatively impacted if the circumstances were reversed.
Business owners commonly use a buy sell agreement to address this type of situation. With the type of agreement called a cross purchase plan, you and your partner would agree on the value of your respective shares in the business.
You would take out life insurance policies on one another equal to the value of a share. Upon the death of one partner, the other partner would use the insurance proceeds to purchase the deceased partner’s share from their estate. As a result, the heir or heirs would have liquidity, and the surviving partner would have total control of the business.
A similar approach can be taken with regard to retirement. However, this would involve the purchase of permanent life insurance with a cash value. When the buy sell agreement is strictly for estate planning purposes, term life insurance that has no cash value would suffice.
We should point out that the cross purchase plan is not the only type of buy sell agreement. There is also the entity or stock redemption plan. With this buy sell agreement, the details are the same with regard to the purchase of life insurance. However, the purchaser is the business itself rather than the individual co-owners.
Another business succession planning scenario that can arise involves people that are running a family business. To use another example, assume that you started a restaurant when you were a relatively young adult.
Over the years, the eatery became quite popular, and you invested in expansion. You have two children, and your daughter started working at the business as soon as she got out of college. Your son decided to embark on a different career path outside of the hospitality field.
When you are planning your estate, you know that your daughter would like to continue to run the business for the rest of her working life, and she has a child who is very interested in the culinary arts. The restaurant is worth a good bit of money, and you want to leave it to your daughter.
At the same time, you love each of your children equally, and you do not want to favor one over the other when it comes to their inheritances. Under these circumstances, you could use life insurance as a business succession planning solution.
You determine the value of the business, and you take out a life insurance policy with your son as the beneficiary. The value of the policy would be equal to the value of the business, and inheritances would be balanced.
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