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Thursday, December 08, 2016
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What is a buy/sell agreement?

 
DISCLAIMER: The purpose of this information is to provide general information which is subject to change and is specific to state law. ReliaQuote is not providing legal advice. If you have a specific legal issue or accounting issue, you should consult with a lawyer who is licensed to practice law in your jurisdiction or a certified public accountant familiar with tax regulations in your jurisdiction.
 
A Buy/sell Agreement is a contractual agreement that provides for the continuation of a business in the event of the death or disability of a sole proprietor, partner or shareholder. An agreement may stipulate that, upon the death of a shareholder or partner of a company, the company or other partners buy back the deceased's interest in the business. Life insurance is commonly used to fund buy/sell agreements because it provides both liquidity and tax advantages in funding the transaction.

The following are important reasons to use a funded buy/sell agreement:

  • Liquidity-A funded buy/sell agreement creates a market instantly for the deceasedís share of the business. Otherwise, if a funded buy/sell agreement were not in place, the purchase of the deceasedís stake in the business would have to come out of the companyís working capital (if there was enough to fund the purchase). In addition, if an outside party were to purchase the deceasedís share, the timing of the transaction could result in a lower valuation of the company because of the death of a key owner and the fact that the deceasedís family wants to sell in a potentially soft market.
  • Transition of Business-A funded buy/sell agreement assists in the efficient preservation and transition of the control and management of the business.
  • Estate Planning-A funded buy/sell agreement can provide cash for potential estate taxes and settlement costs and establish a valuation of the deceasedís business interest for estate tax purposes.
  • Cost-a funded buy/sell agreement funded with life insurance can be inexpensive (the cost for the purchase of a business is essentially the premiums paid for the life insurance policy).
Life insurance provides a simple way to administer a funding vehicle for the purchase of the deceasedís ownership according to the terms of the buy/sell agreement. The business also protects itself from any future drain on working capital, damage to its credit position and/or the legal or financial problems that could arise out of the companyís inability to fund the buy/sell agreement with its own income.