Business succession planning involves creating a plan for someone to either own or run your business after you retire, become disabled, or die.
Many prefer the idea of their businesses continuing even after they are gone and would avoid the business being sold if they knew how this could be accomplished. Important steps in devising an effective plan include: 1) choosing the successor; 2) valuing the business and 3) using life insurance as the standard transfer vehicle. Consideration then must be given as to which buy-sell arrangement is best for you as defined below:
- Cross-Purchase Buy-Sell Agreements. These agreements are structured so that each partner buys and owns a policy on each of the other partners in the business. Each partner functions as both owner and beneficiary on the same policy, with each other partner being the insured. Under a cross-purchase buy-sell agreement, when one partner dies, the face value of each policy on the deceased partner is paid out to the remaining partners, who will then use the policy proceeds to buy the deceased partner's share of the business at a previously agreed upon price.
Example – There are three partners who each own equal shares of a business worth $3 million, so each partner's share is $1 million. All three enter into a cross-purchase agreement, requiring each to take out a $500,000 policy on each of the other two partners. This way when one partner dies, the other two partners will be paid $500,000, which must be used to buyout the deceased partner's share of the business.
- Entity-Purchase Buy-Sell Agreements. The terms of the entity-purchase buy-sell agreement require the business itself to buy a single policy on each partner. The entity becomes both owner and beneficiary on each policy. Upon the death of any partner or owner, the business will use the policy proceeds to purchase the deceased person's share.
3. Reasons to Have a Business Succession Plan
- It ensures an agreeable price for a partner's share of the business thus eliminating the need for valuation upon death because the insured agreed to the price beforehand.
- The policy benefits will be immediately available to pay the decf the business, with no liquidity or time constraints. The value of this is huge sincef an external takeover is prevente or the need to sell the business or other assets to cover the cost of the deceased's interest.
- A succession plan can greatly help in establishing a timely settlement of the deceased's estate.