As a small business owner have you asked yourself what will happen to your business when you die?
• Will your family inherit your business?
• Will your family have to choose between saving the family home and saving the family business?
• What if one of your children wants to run the family business and the others want to sell?
• Does the interested family member(s) have the experience to run the business?
• Will your existing business partners want to be in business with your family or vice versa?
• Can your business partners afford to pay your family a fair share to buy the business?
These are questions that every small business owner must face. And perhaps you’ve asked yourself these questions 1,000 times or more, but have yet to put a solution in place. Although we cannot answer these questions for you, we can provide effective solutions for your answers.
Here is an example of one solution called a cross-purchase agreement:
Kelsey and Mai are business partners in a popular and growing bakery enterprise. They have a storefront and also sell their bakery goods online. Their business is currently valued at $2 million dollars. In the event of Mai’s death, Kelsey plans to become the sole owner and vice versa. Therefore, they will both need $1 million to buy out their partner’s share. Upon her death, the $1 million would be paid to Mai or Kelsey’s respective families.
Mai buys a $1 million insurance policy on Kelsey. Mai owns the policy and she is also the beneficiary. Likewise Kelsey buys a $1 million policy on Mai. Kelsey owns this policy and she is also the beneficiary in the event of Mai’s death.
Either term insurance or permanent insurance could be used, but in this example having a policy that builds cash value would probably work best. As an example, an Indexed Universal Life (IUL) policy
would allow for cash value growth in the policy and can provide an increasing death benefit to mirror the growth in the bakery business. Additionally, in the event of retirement, disability, or perhaps one partner simply wants to call it quits, the permanent policy has a cash surrender value that could be used to buy out the other partner’s share.
Buy-sell agreements are always based on the current value of the business. Therefore, Mai and Kelsey need to have periodic reviews to make sure the policy growth is keeping up with their business growth.
Let’s say Mai dies first. At this point Kelsey would use the proceeds from the policy to purchase Mai’s share of the business with the proceeds going to Mai’s family. Kelsey’s cost basis will be increased by $1 million for tax purposes which is referred to as a “step-up” in basis.
Even though a life insurance policy provides a solution, Mai and Kelsey will have to consult their tax accountant and an attorney to draw up the legal agreement. This is not something that an insurance agent can do nor could the terms of sale be spelled out in the life insurance policy.
A cross-purchase agreement may not be the best option in every situation. For instance, if there is a large age difference between the partners or one partner has health issues, then the younger or healthier partner ends up paying larger premiums to insure the older or less healthy partner.
In this case, an alternative buy-sell agreement may be a better option for the partnership. Funding a buy-sell agreement with life insurance provides a low-cost option because the policy premium will always be significantly less than the death benefit amount required for the buyout.
Your questions have answers. It’s a conversation worth having, with solutions we can provide through our partnerships with A-rated insurance carriers.
Fill out a short form and we can provide you with the policy options to best match your coverage and financial needs.
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