If you are a partner in a small business, when you start to think about your legacy, the situation can be challenging on the surface. The best way to explain is through the utilization of a simple example.
Let’s assume that you own a very successful restaurant with one partner. You and your partner own the building and the equipment, and it is perfectly situated in an important, well trafficked part of town. The business is your most significant investment by a wide margin, and your partner is in the same position.
You would want to continue to run the business independently if your partner was to pass away, and she feels the same way. How do you account for a situation like this?
A commonly embraced solution would be a legal arrangement called a buy-sell agreement. Under the scenario that we have laid out, the appropriate agreement would be the cross purchase plan. First, you and your partner would get together to agree upon the value of a share in the business.
You would then take out life insurance policies on one another that pay out proceeds equal to the value of a share. When one partner dies, the surviving partner would use the insurance policy proceeds to purchase the share that was owned by the deceased partner from their family.
Going forward, the surviving partner would be able to operate the business as usual, and the family would have liquidity that could be spread around among multiple different people.
There is another type of buy-sell agreement called the equity purchase plan. Everything is the same, except the business as an entity takes out the life insurance policies on the individuals that own equity shares.
While we are on the topic of how life insurance could be used to meet certain estate planning challenges, we should touch upon the subject of inheritance balancing. If you own a valuable business, and you want to leave it to one of your children, how do you provide for your other children equally?
The solution would be life insurance purchases that balance the inheritances. You determine how much the business is worth, and you buy life insurance policies that will pay out the same amount to your other child or children.
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