Buy-Sell Insurance in New England
Buy-sell insurance is life and disability insurance designed to fund a buy-sell agreement between two or more partners in a business. When an owner dies, becomes disabled, or exits the business, the insurance proceeds allow the remaining partners or the company to purchase the departing owner’s interest — rather than attempting to use business cash flow or forcing an outside sale.
Without a funded buy-sell agreement, the death or disability of a business owner can create an ownership crisis: the surviving partners may find themselves in business with the deceased owner’s heirs or facing a forced asset sale to satisfy an estate. A properly structured buy-sell agreement, funded with insurance, provides a clear and orderly transition that protects everyone involved.
Cleary Insurance works with Massachusetts and New England business owners and their attorneys to evaluate their buy-sell needs and find the right insurance structure to fund the agreement.
How Buy-Sell Insurance Works
A buy-sell agreement is a legal contract that specifies what happens to a business owner’s interest if they die, become disabled, retire, or otherwise exit the business. Insurance funds the agreement by providing the cash needed to purchase that interest at the agreed value. Without insurance, the surviving partners must either use business assets, take on debt, or find outside capital — all of which create significant operational and financial risk.
Buy-sell insurance is typically structured in one of two ways: a cross-purchase arrangement, in which each partner owns a policy on the other partners’ lives; or an entity purchase (redemption) arrangement, in which the business owns the policies and uses the proceeds to buy back the departing owner’s interest. The right structure depends on the number of partners, the business entity type, and the tax implications of each approach.
Frequently Asked Questions
What is a buy-sell agreement?
A buy-sell agreement is a legally binding contract between business co-owners that governs the sale of a partner’s interest when a triggering event occurs — typically death, disability, retirement, or a voluntary exit. The agreement establishes who can buy the interest, at what price or valuation method, and on what terms. Without a buy-sell agreement, these decisions are left to chance, family members, or courts. Cleary partners with your business attorney on the insurance component of the agreement.
What triggers a buy-sell agreement?
The most common triggering events are the death of a partner (funded with life insurance), disability of a partner (funded with disability buy-out insurance), retirement, voluntary departure, and sometimes a divorce or personal bankruptcy. Death and disability are the triggers that insurance addresses directly. Buy-out disability insurance is distinct from individual disability income insurance; it is designed specifically to fund a partner buyout rather than replace personal income.
How is the business value determined for buy-sell purposes?
The buy-sell agreement must specify a method for determining the value of the departing owner’s interest. Common approaches include a fixed price set at the time the agreement is signed (which must be updated regularly), a formula method based on revenue or earnings multiples, or a third-party appraisal at the time of the triggering event. The insurance coverage amount should be aligned with the valuation method in the agreement. Cleary works with your attorney and accountant to make sure the insurance amount matches the actual business value.
What is the difference between a cross-purchase and an entity-redemption buy-sell?
In a cross-purchase structure, each partner owns a life insurance policy on every other partner. If Partner A dies, Partner B collects the insurance proceeds and uses them to buy Partner A’s interest. In an entity (redemption) structure, the business itself owns the policies and uses the proceeds to buy back the deceased partner’s interest. Cross-purchase arrangements can result in a higher cost basis for the surviving partners when they eventually sell; entity structures are simpler to administer, especially when there are more than two partners. Cleary and your tax advisor will identify which structure is more advantageous for your situation.
How often should a buy-sell agreement and its insurance funding be reviewed?
A buy-sell agreement and the insurance that funds it should be reviewed whenever there is a significant change in business value, ownership structure, or a partner’s personal situation. Business values change, and an insurance policy written ten years ago may no longer match today’s business valuation. Cleary recommends a formal review of buy-sell insurance at least every three years, and immediately following any major transaction, partnership change, or valuation event.