Buy-Sell Insurance

Many businesses with more than one owner have a shareholders’ agreement that includes buy-sell provisions - terms setting out what happens to an owner's share when an owner dies or can no longer continue. It is sound planning, and part of what makes it work is having the funding ready so the buyout can be carried out when it is needed.

What Buy-Sell Provisions Do

Buy-sell provisions are usually included in the shareholders’ agreement and govern how an owner's share will change hands - who may buy it, how it will be valued, and under what circumstances a buyout is triggered. The purchase can be structured among the owners, by the corporation itself, or as a combination of the two. Among the triggers is the death of an owner, which is where life insurance comes in. In effect, it is a plan agreed in advance for a moment that might otherwise be difficult and contested. The shareholders’ agreement is typically drafted with legal counsel, and its structure carries tax and valuation considerations best worked through with the appropriate advisors.

How Life Insurance Is Used

A shareholders’ agreement typically sets out not only the terms of a buyout but how it will be funded, and life insurance is one of the most common ways to provide that funding - an arrangement often referred to as buy-sell insurance. Policies can be arranged on the owners so that, on the death of an owner, a payment becomes available to help fund the buyout under the agreement's terms. Depending on how the arrangement is structured - including who owns the policies and who is named as beneficiary - the proceeds can go to the corporation or the remaining owners to put toward purchasing the share, easing the need to draw on personal savings or business assets. The purchase price itself is set by the valuation provisions in the agreement, while the life insurance helps supply the liquidity to meet it. The death benefit is generally received tax-free, though how proceeds are treated and flow through a corporation can be more nuanced - a point to confirm with a tax advisor.

Keeping It Aligned

A buy-sell arrangement is not something to set once and forget. The value of a business changes over time, and coverage that matched it a few years ago may no longer reflect what a share is worth today. The agreement's valuation method and the amount of funding behind it are both worth revisiting periodically, so that the money available continues to match the obligation the agreement creates. An arrangement that stays current is one that still works when it matters.

A plan is only as good as its funding.

Buy-sell provisions decide, in advance, how ownership will change hands. Funding is what turns that decision into something the business can act on - so that the departure of an owner becomes a transition the company can manage smoothly. Designing it well brings together law, tax, valuation, and life insurance, and getting those pieces to work together is a straightforward conversation worth having before the need arises.

An upcoming edition of Employer Insights will take a closer look at buy-out insurance, which uses disability insurance to help fund the purchase of an owner's interest if they become disabled and a claim qualifies under the policy.