People who are involved in small business partnerships have some unique realities to address when they are planning for the future that those who work for others don’t have to concern themselves with. When you have a significant stake in a business that investment may well represent the lion’s share of your estate, but extracting it in the event of your death can be a very tricky matter.
First of all your loved ones may have no particular interest in filling your role as a partner in your business. This is understandable, and even if you did have an heir or heirs who wanted to succeed you your partners may not feel comfortable with this arrangement. At the same time, if one of your partners was to become disabled or pass away you and any remaining partners that may exist would probably want to have the freedom to either move on without the deceased partner or bring in others as you see fit.
These small business succession situations are often addressed via the creation of buy-sell agreements. The two most commonly used forms of these agreements are the cross purchase agreement and entity plan, and these are the ones that we will touch upon.
With a cross purchase agreement the partners come up with an agreed-upon valuation of the business and they buy life insurance policies on one another, the proceeds of which equal one partnership share. Should one of the partners become disabled or pass away, the insurance benefits are used to buy out the deceased partner’s share of the business from his or her family.
The entity agreement is similar. With this plan the business entity itself takes out an insurance policy on each of the owners equal to his or her share of the business. Should any of the partners pass away or become disabled, the proceeds from the insurance policy are used to purchase the business share of the deceased from his or her heirs.