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How Insurance Can Make a Buy-Sell Agreement “Easy” for Death or Disability
For small San Diego and California businesses, it is important that the owners agree early in the process to a buy-sell agreement. This applies whether you are running your business as a general partnership, a corporation, a professional corporation, a limited liability company, or any other format. A buy-sell agreement is an agreement made between the owners about the terms and conditions under which owners can sell their ownership interest, can be forced to sell their ownership interest, and what happens in the event of death, disability, retirement, bankruptcy, and divorce of an owner.
The purpose of the buy-sell is to keep the business running under the current ownership. The death, divorce, or personal bankruptcy of an owner can have large repercussions for the business. The family of the deceased owner or the divorced spouse or the bankruptcy trustee may want to become intimately involved in how the business is run. As new owners, they may have voting rights and other rights that will clash with the preexisting owners. No one wants that.
A buy-sell agreement must be made early while everyone is on good terms so that there is a basic “fairness.” Often the biggest hitch in cementing a good buy-sell agreement is how to fund the purchase price. In this article, we discuss how life and disability insurance can be used as an effective part of a buy-sell agreement to deal with death and disability.
San Diego Closely-Held Businesses: Using Insurance as Part of a Buy-Sell Agreement
Any good buy-sell agreement must make some solid, understandable, and fair provision for how the purchase price will be paid in the event that a sale or purchase is triggered.
One option is to require that the owners purchase life and disability insurance – or better yet, everyone agrees that the company will buy life and disability insurance for all the owners. The idea is that the insurance will provide sufficient cash at the time of the death or disability to fund the buy-sell. In addition to requiring the purchase of insurance, the buy-sell agreement should state that the company is owner of the policies and that the Company is the beneficiary of the policies. Alternatively, if the buy-sell agreement is set up as an owner’s cross-purchase agreement, then the owners are collectively the owners and beneficiaries of the insurance policies Also, provisions must be in place for automatic increases in the payout from the policies to track increases in the value of the ownership interest. Again, the purpose is to be able to use the insurance proceeds as the purchase money to buy the ownership interest of the deceased or disabled owner.
Other needed provisions:
- What happens to the insurance policies if the business terminates — ownership, beneficiaries
- Procedures in the event that the insurance proceeds do not provide for the full purchase price
- Rules if the insurance proceeds exceed the purchase price
- Exclusive remedy provisions to avoid litigation
- Provisions binding on heirs and assigns to avoid collateral challenges from the estate and family
With respect to disability insurance, the owners must be careful to purchase suitable disability products to provide cash for the buyout, but also ongoing monthly payments for now-disabled owner.
San Diego Closely-Held Businesses: Contact San Diego Corporate Law
For further information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has the experience to help you create and review any needed buy-sell agreement, review, create, and assist in executing business contracts, and assist with any business-related matter. Contact Mr. Leonard by email or by calling (858) 483-9200.
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