What is Entity-Purchase Agreement
An entity-purchase agreement is a type of business succession plan used by companies that have more than one owner. The plan involves having the company take out an insurance policy on the lives of owners in the amount equal to each owner's interest. In the event of death, the amount collected by the company from the insurance, which is equal to the deceased owners stake, is used to pay the deceased's estate for its share of the business.
BREAKING DOWN Entity-Purchase Agreement
The advantage of an entity-purchase agreement-based succession plan is that the owners know their respective stakes in the company will be paid out to their estates, and that the company will continue to be run by the other partners. Having this type of succession plan, (which is paid for by the company) allows the owners to avoid any out-of-pocket expenses while also looking after their families in the event of death. When the entity in question is a corporation, an entity-purchase agreement may be referred to as a stock redemption agreement. In such cases, the business itself will enter into an agreement with each owner to purchase a deceased owner’s business interest. The agreement requires that a deceased owner’s estate sell the business interest and that the business entity must buy the deceased owner’s business interest. The agreement also establishes the price to be paid either based on a fixed amount or a formula.
Under this type of arrangement, the business entity buys a life insurance policy on the life of each owner, based on the value of that owner’s ownership interest. In successful businesses, additional insurance would be purchased as the value of the business continued to increase in value.
Advantages of an Entity-Purchase Agreement
- Creates a market and establishes a fair price for the business interest
- Provides the funds to make the purchase
- Avoids a forced sale of assets
- Can provide liquidity to the estate of the deceased/retired business owner
- Creates a smooth transition for management and control of business
- The deceased’s estate is assured prompt and full payment
- The number of policies that need to initially be purchased is limited to one policy for each owner
- Because the business is paying the insurance premiums, there is a pro-rata share of the costs between the owners according to their share in the business without concern as to age, smoker status or health ratings
- Life insurance cash values are shown as an asset on the business balance sheet