Taxation and Business Uses of Insurance - Business Uses of Life Insurance

BUY-SELL AGREEMENTS
Owner's of a closely held business need to consider how the ownership of their business is to be transferred upon certain life changing events. Business succession planning is a key element of any business owner's financial plan. There are several key elements to consider when creating a business succession plan. One of the more common ways to transfer ownership is through a buy-sell agreement between business owners. Most often this agreement will serve as the key element to any succession plan.

Definition
A contractual agreement outlining how the ownership of a business is to be transferred upon one or more of the following events:

  • Retirement
  • Death
  • Disability
  • Bankruptcy
  • Divorce

Typically, the ownership is transferred through the sale of interest in the company. The price of the sale is determined by a formula outlined in the contract.

Advantages of a Buy-Sell Agreement
There are many advantages to this type of agreement. When selling interest in a business, it is difficult to guarantee that a market will exist. When there is no market for the sale of a business the owner or the owner's family will have to retain the interest. This can create an unwanted burden for the family or withdrawing owner. Also, in the instance of the death of an owner a large estate or death tax liability may exist. A buy-sell agreement creates liquid assets available for the payment of the estate or death tax. The agreement can also establish the value of an owner's business interest thus, easing the estate planning process. Most importantly, an agreement will guarantee the proper continuation of the business. This decreases the overall risk taken by the owner's of a business, increases a businesses credit rating, and makes the business more favorable to would be investor's.

Practice Question:
Bobby is one of three owners in ABC Corporation. All three owners have equal interest in the business. The owners have decided to establish a cross purchase buy-sell agreement funded with life insurance. According to the contractual agreement the business is worth 10 million dollars. How many life insurance policies will Bobby need to purchase and how much life insurance must he purchase on each owner to fully fund his portion of the agreement?

A. 1; $10,000,000
B. 1; $3,333,333
C. 1; $1,666,666
D. 2; $3,333,333
E. 2; $1,666,666

Answer: E
Bobby would need to purchase 2 policies (one for each owner other than himself). If the value of the business has been established as $10,000,000 each owner owns $3,333,333 of the business. If one of the owners was to die their family would need to receive $3,333,333 for the value of his/her share. Therefore each owner must buy 2 policies valued at $1,666,666 (2 * 1,666,666 = $3,333,333) a piece. Structure and Tax Considerations of Buy-Sell Agreements
Related Articles
  1. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
  2. Products and Investments

    How to Create a New Financial Product in 10 Steps

    The 10 steps outlined here are essential to the creation of a new financial product.
  3. Professionals

    A Day In The Life Of A Public Accountant

    Here's an inside look at the workdays of two experienced CPAs, to give you an idea of what it might be like to pursue a career as a public accountant.
  4. Professionals

    A Day in the Life of a Public Accountant

    There’s no typical day in the life of a public accountant, but one accountant’s experience may shed some light on what the career entails.
  5. Saving and Spending

    A Key Tip for Making Your Nest Egg Last Longer

    Retirees who don't want to deplete their nest eggs during a bear market should make sure to do the following.
  6. Mutual Funds & ETFs

    Fidelity Target Risk Funds Overview

    Get a brief overview of Fidelity's seven target risk funds, with a description of each fund's asset allocation and expense ratio.
  7. Investing News

    Is it the Right Time to Raise Interest Rates?

    Warning signs have started to emerge that point to a potentially dismal 2016 for the U.S. economy.
  8. Markets

    Four Big Risks of Algorithmic High-Frequency Trading

    Algorithmic HFT has a number of risks, and it also can amplify systemic risk because of its propensity to intensify market volatility.
  9. Mutual Funds & ETFs

    The Top 3 Invesco Funds for Retirement Diversification in 2016

    Explore analyses of the top three Invesco mutual funds for retirement diversification in 2016, and learn about the characteristics of these target-date funds.
  10. Investing Basics

    Hedging Risk for Beginners: How and When to Do It

    Hedging risk is always a good idea. Here is how sophisticated investors go about it.
RELATED TERMS
  1. Sortino Ratio

    A modification of the Sharpe ratio that differentiates harmful ...
  2. Equity Risk Premium

    The excess return that investing in the stock market provides ...
  3. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  4. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  5. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  6. Gross Exposure

    The absolute level of a fund's investments.
RELATED FAQS
  1. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  2. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  3. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  4. Why are mutual funds subject to market risk?

    Like all securities, mutual funds are subject to market, or systematic, risk. This is because there is no way to predict ... Read Full Answer >>
  5. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  6. Can your car insurance company check your driving record?

    While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
Hot Definitions
  1. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  2. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  3. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  4. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  5. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
Trading Center