Small business owners face some unique challenges when they are planning their estates that others do not. Many individuals who have invested their time and efforts in a small business partnership would say that their share in the business is their most valuable financial asset.
But how do you pass this considerable asset on to your loved ones after your death? Many people have no relatives that would be appropriate successors in the hands-on operation of the business, and the surviving partners may not want to work alongside an heir of their deceased partner even if someone did step forward.
If the family of the deceased partner were to sell his or her share to the highest bidder, the remaining partners would be faced with the prospect of a new co-owner that they had no control over bringing into the fold. This is not an option that is going to be acceptable to most people.
To avoid disputes and disruption, small business succession is instead often handled by creating buy-sell agreements. The partners determine the monetary value of each share in the business. Under the cross purchase plan, they then take out life insurance on one another. When one of the partners passes away, the insurance proceeds are used to purchase the deceased partner’s share from his or her family at a price that was mutually agreed upon when the agreement was entered into.
Another option is an entity plan. It is very similar in that it involves the purchase of life insurance that is ultimately used to buy the share of a deceased partner from his or her heirs. But rather than each owner taking out policies on each other, the business entity itself purchases the life insurance policies.