Prepare your company for a co-owner’s exit.
If one of a company’s owners departs, a buy-sell agreement can help to secure the financial well-being of the company and any individuals involved, while passing along control of the company.
Since it helps protect the owners, it is mutually beneficial, making it an essential to any co-owned company and any family business. If one of the owners passes away, becomes disabled, retires or is terminated, the buy-sell agreement is activated and starts being helpful. Essentially, this agreement would follow the wishes of the owners laid out in the agreement.
There are basically two types of buy-sell agreements: a stock redemption (entity purchase) plan or a cross purchase plan. Although these two agreements widely cover the same terms and conditions, there are some differences.
Stock Redemption or Entity Purchase Plan
Under an entity purchase plan, the business purchases an owner’s entire interest at an agreed upon price if a triggering event occurs. If the business is a corporation, the plan is referred to as a stock redemption agreement. In the context of a partnership, it is called a liquidation of interest.
If life or disability insurance is used to fund the agreement, the business owns the insurance on the lives of each stockholder and then uses the proceeds to purchase (redeem) their stock at death or disability. This plan can be relatively straightforward as the business is the owner, premium payer and beneficiary of the policies.
If whole life insurance with cash value is used as part of the agreement, the cash value is recorded as an asset of the business on the balance sheet. It is important to note that, depending upon the structure of the corporation, there are different tax implications to consider when using an entity-purchase plan.
Cross Purchase Plan
A cross purchase plan requires each stockholder in a company to purchase and own life insurance on the lives of the other stockholders. Each owner pays the premiums and would be the beneficiary of the policy. The face amount of the policy would be equal to the others’ ownership interest.
Upon the death of one owner, the insurance proceeds would be used to purchase the ownership interests from the deceased owner’s estate or family.
This plan may become too cumbersome if there are more than two stockholders. In this situation, the owners could use a “trusteed” cross-purchase arrangement. Here a trust would own one policy on each stockholder and represent the others in the transaction, eventually distributing the deceased shareholder’s stock to the remaining stockholders.
Disability buy-sell insurance can also be used in a cross purchase agreement to facilitate transfer of ownership upon the total disability of a stockholder.
To start the process of obtaining a buy-sell agreement, contact legal counsel to begin laying out the preferred terms. Once the original plans are created, it is recommended to review and update once every three to five years.
Securities and investment advisory services offered through registered representatives of MMLInvestors Services, LLC, Member SIPC (www.sipc.org). Supervisory office: 4801 Gaillardia Parkway, Suite 250 Oklahoma City, OK 73142, (402) 486-1400. Twin Financial is not a subsidiary or affiliate of MML Investors Services, or its affiliated companies. CRN201808-204704