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Insuring Your Business With a Buy-Sell Agreement

Life insurance can help protect a household after the death of a primary wage earner. For business owners, a similar question applies, and a buy-sell agreement is one way to address it: What happens to the business if an owner dies or becomes disabled?

A buy-sell agreement can help answer that question before a crisis occurs.

A buy-sell agreement is a legal contract that explains how an owner’s interest in a business may be transferred if certain events occur, such as death, disability, retirement, divorce, or voluntary departure.

At True North Wealth Management, we help business owners think through succession, continuity, insurance funding, and how business decisions connect to personal financial goals.

Why a Buy-Sell Agreement Matters

Without a written plan, a business owner’s death or disability can create uncertainty for the company, the remaining owners, employees, clients, and the owner’s family.

A buy-sell agreement can help:

The agreement can also help the deceased or disabled owner’s family receive value for the business interest without needing to participate in daily operations.

Common Types of Buy-Sell Agreements

Business owners often use one of two common structures.

Cross-Purchase Agreement

In a cross-purchase agreement, the remaining owners agree to buy the departing or deceased owner’s share.

Each owner may purchase life insurance on the other owners. If one owner dies, the surviving owners receive the policy proceeds and use those funds to buy the deceased owner’s business interest.

This structure may work well for businesses with a small number of owners. It can become more complicated when several owners are involved because each owner may need to own policies on the others.

Entity-Purchase or Stock-Redemption Agreement

In an entity-purchase agreement, sometimes called a stock-redemption agreement for corporations, the business itself agrees to buy the departing or deceased owner’s interest.

The business may purchase life insurance on the owners. If an insured owner dies, the business receives the policy proceeds and uses them to redeem or purchase that owner’s interest according to the agreement.

This structure may be simpler when there are multiple owners, but it can have different tax, accounting, and ownership consequences.

Funding the Agreement

A buy-sell agreement is only as strong as the funding behind it.

Business owners may consider several funding options.

Set Aside Cash

The business or owners may set aside cash to fund a future buyout. This approach can work, but it requires discipline. Funds may be needed for years, and owners may be tempted to use the money during difficult business cycles.

It can also be hard to know whether enough cash will be available when the triggering event occurs.

Borrow the Money

The business or remaining owners may try to borrow the funds when a buyout becomes necessary.

This can create challenges. A death or disability may weaken the company’s financial position, reduce lender confidence, or add debt service at an already stressful time.

Use Life Insurance

Life insurance is commonly used to help fund a buy-sell agreement after an owner’s death.

Instead of waiting to accumulate the full buyout amount, owners or the business pay premiums over time. If an insured owner dies while the policy is in force, the death benefit may provide liquidity to complete the buyout.

Life insurance can help create a more predictable funding source, but it must be structured carefully.

Disability Should Also Be Considered

Death is not the only risk.

A long-term disability can also create ownership and cash-flow issues. The owner may no longer be able to work, but may still own part of the company.

A buy-sell agreement should address what happens if an owner becomes disabled, how disability is defined, how long the disability must last before a buyout occurs, and how the buyout will be funded.

Disability buyout insurance may be considered in some situations.

Business Valuation Is Critical

A buy-sell agreement should explain how the business will be valued.

Common valuation approaches may include:

An outdated or unclear valuation method can create conflict. Business owners should review the agreement periodically to make sure the valuation method still reflects the business.

Buy-sell agreements involve legal, tax, insurance, and financial planning considerations.

Before implementing or updating an agreement, business owners should work with qualified professionals to review:

At True North Wealth Management, we help business owners coordinate these conversations with attorneys, CPAs, insurance professionals, and valuation specialists.

Protect the Business You Built

A business can represent years of work, risk, sacrifice, and family wealth.

A buy-sell agreement can help protect that value by creating a clear plan before death, disability, or an ownership change occurs.

When properly structured and funded, the agreement can give remaining owners a path forward and provide the departing owner or family with a more orderly financial outcome.

For business owners, succession planning is not only about the future of the company. It is also about protecting the people who depend on it.

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Important Disclosures:
This material is for informational purposes only and is not intended as tax, legal, accounting, insurance, business valuation, succession-planning, or individualized financial advice. Buy-sell agreements are legal contracts and should be drafted and reviewed by qualified legal counsel. Life insurance and disability insurance are subject to underwriting, policy terms, exclusions, fees, expenses, and limitations. Guarantees depend on the claims-paying ability of the issuing insurance company. True North Wealth Management does not provide tax or legal advice. Consult qualified tax, legal, insurance, valuation, and financial professionals regarding your circumstances.

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite and customized by True North Wealth Management LLC to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright FMG Suite.