Term Life insurance can help ensure a business transfer!
The Problem
- Business Continuation and Transfer
In the case of the sole proprietorship, the partnership, and the closely held corporation, the problems of business stability and continuation following the death or disability of an owner are critically important to both the family of the deceased owner, the surviving owners, and the employees. In order to understand the role life insurance plays it is necessary to understand the effects that the death or disability of an owner can have on the business.
Partnerships- The Problem Explained
The partnership form of business organization has many advantages, however, the law provides that upon the death of a general partner, the partnership is dissolved and the surviving partners become liquidating trustees, charged with the responsibility of immediately winding up the business and paying over to the estate of the deceased a fair share of the liquidated value of the business.
The liquidation of a business, were a forced sale of assets, almost always results in major shrinkage of those assets.
Under these circumstances, the following will occur:
-devaluation of assets
Accounts receivable will bring only a fraction of their normal value, inventory and plant must be disposed of at sacrifice prices, and
-goodwill will be lost
means of earning a living are gone
The seriousness of the consequences often leads survivors to attempt to continue the business by buying out the interest of the deceased partner and reorganizing the partnership. This procedure is not practicable, however, for two reasons. In most cases, it is not possible to raise the necessary cash. But even if the surviving partners can raise the cash to purchase the interest of the deceased, they have to prove that the price paid for the interest is fair. Their fiduciary status makes this impracticable; in fact, in some states, they are not permitted to purchase the interest, since it in effect involves a trustee's purchasing trust property. In the usual case, it is also impracticable for an heir to become a member of the reorganized partnership or to purchase the interests of the surviving partners. The record of litigation is clear.
The Solution
In order to avoid this consequence, the members of a partnership would enter into a buy-and-sell agreement arrangement. This would bind the surviving partner(s) to purchase the partnership interest of the deceased partner. A prearranged price is set forth in the agreement, and obligates the estate of the deceased partner to sell the interest to the surviving partners. The value of the various partnership interests is determined at the time the agreement is enter into and may be periodically revalued in the agreement. Each partner is insured by life insurance for amount of his interest. The other partners or the partnership itself owns the policies. When the first partner dies, the buy-sell agreement is set into motion. The life insurance proceeds are used to purchase the interest of the deceased from his or her estate. The partnership is reorganized by the surviving partner and continued in operation, and the heirs of the deceased receive in cash the value of their interest in the partnership. All parties benefit by the arrangement, and the problems of liquidating the partnership are solved. The surviving partners can now enter into a new buy-and-sell agreement or amend the original agreement to account for changes in the value of the survivors’ respective interests.
Professional Service Partnership
Rather then a buy-sell agreement, lawyers, doctors, and other professions often us an income continuation arrangement. It provides that for a given number of years the business will share a percentage of its profits with the heirs of the deceased or pay a fixed sum for a period of time.
Two agreements may apply in some cases. A buy-and-sell agreement can cover assets, and an income continuation agreement can cover the deceased's share in future earnings. Life insurance is used as the funding method for both types of agreement.
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Closely Held Corporations Corporate Buy Sell Agreements
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