Funding a Business Buyout with Life Insurance: What Every Partner Should Know

In business partnerships, one of the biggest “what if” questions is: What happens if my business partner dies unexpectedly?

Without a clear plan, and the funds to execute it, the surviving partner(s) could be left scrambling to keep the business afloat, settle the estate, or negotiate with grieving family members. That’s where cross-purchase buy-sell agreements funded by life insurance come in.

Why You Need a Buy-Sell Agreement in the First Place

A buy-sell agreement is a legal contract that outlines what happens to an owner’s share of the business if they pass away, become disabled, or exit the company. In a cross-purchase agreement, each partner agrees to buy out the other’s share upon death, ensuring control of the business stays in trusted hands.

But a contract is only part of the equation. Without a funding mechanism, the buyout may never happen.

Life Insurance: The Most Efficient Funding Tool

Life insurance is the simplest and most cost-effective way to fund a buy-sell agreement. Each business owner purchases a life insurance policy on the other(s), with themselves as the beneficiary. If one partner passes away, the surviving partner receives the death benefit and uses it to buy the deceased partner’s share of the business.

It’s clean. It’s fast. And it avoids liquidating business assets or taking on debt to complete the buyout.

According to a 2023 LIMRA and EY report, only 35% of small business owners have a formal succession plan, and of those, many do not have adequate funding in place to execute it.

Ownership Structure and Tax Implications

In a cross-purchase setup, each partner owns a policy on the other. This contrasts with an entity-purchase agreement, where the business itself owns the policies.

The structure impacts taxation and the number of policies needed:

• Two partners? Each owns a policy on the other (2 total).
• Three partners? Each owns a policy on both others (6 total).

And so on…

Premiums aren’t tax-deductible, but the death benefit is generally received tax-free by the beneficiary under IRC 101(a), and increases the cost basis in the purchased shares, an important benefit for capital gains planning.

Final Thoughts

A buy-sell agreement without funding is a promise without a plan. Life insurance helps turn that promise into protection, ensuring your business remains in stable, capable hands no matter what.

Want to protect your company’s financial future? Contact our office today or your attorney to explore the right structure for your business and your partners.