Strategies for Buy-Sell Agreements Using Insurance

Buy-sell agreements are critical when dealing with a closely held business and yet often ignored or given short shrift by business owners. Life insurance is an effective tool that business owners can use to implement the provisions of a buy-sell agreement by providing liquidity at the death of an owner to both his or her business and family. Having a properly drafted buy-sell agreement is key in avoiding conflict and memorializing how life insurance proceeds are to be used at the death of a business owner. The creation of a separate entity to hold life insurance is increasingly being used by practitioners in buy-sell agreement planning to avoid tax traps and other pitfalls.

What is a buy-sell agreement?

In very general terms, a buy-sell agreement (which may be part of a shareholders’ agreement, an operating agreement, a partnership agreement, or other agreement) is an agreement among owners of a closely held business that restricts the rights of the owners to transfer their interests in the entity. It also usually gives the other owners and the entity, in some combination, the right (and sometimes the obligation) to purchase the interests of an owner when the owner dies or wishes to make a lifetime transfer of his or her interests. Accordingly, a properly drafted buy-sell agreement can prevent the interests of a deceased business owner from passing to others whom the remaining owners would not want to have interests in the entity, and it can also provide liquidity to the estate of a deceased owner. 

The triggering events for a buy-sell agreement can go beyond death and voluntary lifetime transfers. A possible involuntary transfer, such as one that could result from a divorce or bankruptcy, can also trigger purchase rights or obligations. Other events might include the owner’s permanent disability or the termination of an owner’s employment with the entity. 

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