By Jeff Feakes
From the Spring 2019 Journal of the Colorado Dental Association
As a partner or co-owner of a dental practice, you’ve spent years building a valuable financial interest in your business. You may have thought of additional ways to protect your business and your family should something happen to you but are unsure of the appropriate methods to accomplish this. One of the most common methods is a buy-sell agreement. Buy-sells ensure, upon passing, that the surviving members of your family experience a smooth sale of your business interest. The most common vehicle (and most cost effective) is funding this objective through life insurance. The life insurance that funds your buy-sell agreement will create a sum of money upon your death that will be used to pay your family or estate the full value of your ownership interest.
How Funding Works
When using life insurance with a buy-sell, either the company or the individual co-owners buy life insurance policies on the lives of each co-owner. If you were to die, the policyowners (or company) receive the death benefit from the policies on your life. That money is paid to your surviving family members as payment for your interest in the business. If all goes well, your family gets a sum of cash they can use to help sustain them after your death, and the company has ensured its continuity. From this scenario we can see several advantages:
- The life insurance created a lump sum of cash and offered immediate liquidity to the surviving family.
- The liquidity offers a smooth transition, and the practice can move on quickly and efficiently.
- The agreement removes questions on next steps for the practice, and the surviving family doesn’t feel pushed into an uncomfortable situation.
Different Types of Buy-Sell Agreements
There are two main types of buy-sell agreements:
- The organization or entity owns the coverage on the co-owners (entity purchase), or
- The co-owners own the coverage on each other (cross-purchase).
In an entity purchase buy-sell agreement, the business itself buys separate life insurance policies on the lives of each of the co-owners. The business is then responsible for paying the premiums, and the business is the owner and beneficiary on all policies. When dealing with an entity purchase agreement, it’s important to have additional documentation in your business plan as to how ownership will change after the death of a co-owner and when proceeds from the buy-sell are sent to the co-owner’s estate. This type of buy-sell is typically put in place when more than two owners exist.
In a cross-purchase agreement, each co-owner buys a life insurance policy on each of the other co-owners. The co-owner usually pays for the premiums on the policies they own, and the co-owner is also the primary beneficiary for each owned policy. If the practice has multiple co-owners, multiple policies must be purchased on everyone that has an ownership interest. The cross-purchase buy-sell agreement is most common in partnerships or practice acquisitions.
Fully Fund the Buy-Sell Agreement
The amount of insurance coverage on your life should equal the value of your ownership interest. In other words, if your interest in the practice is valued at $1M, then your life insurance value should equal $1M. Upon death, there will be enough cash from the life insurance policy proceeds to pay your family or estate in-full for your share of the practice. However, if you can only afford life insurance coverage for your portion of your interest, fund that amount. Later down the road, the company may be able to increase the amount of insurance or use additional funding methods. In the meantime, the agreement should specify how your family or estate will be paid.
Changing Business Value
What if your insurance proceeds turn out to be less than the value of your business interest, due to the growth of the business? Your surviving family members might end up getting less than the full value of your business interest. Your buy-sell agreement should specify how valuation differences will be handled, and you should regularly review coverages to make sure full interests will be properly funded.
Keep Track of Your Agreement
Each year policy premiums will be due, so it’s important to make sure coverages are in good order and do not lapse. Reviewing your agreement regularly with your insurance broker/financial advisor should be a priority. Additionally, you should strive to build your team of a financial advisor, CPA and estate planning attorney with full transparency and fluid communication in the event of death or disability. Buy-sell agreements create appropriate succession planning. When your main focus is growing your practice, it’s important to have a plan in place so you won’t have to worry about how your business or business interest is transferred upon your passing.
Jeff Feakes is an account executive with COPIC Financial Service Group, an endorsed company of the Colorado Dental Association for insurance products and services. Contact Jeff at 720-858-6285 or jfeakes@copic.com, or visit callcopic.com.
To the extent that this material concerns tax matter, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his/her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable. The information in these materials may change at any time and without notice.