When business partners build a company together, one of the greatest risks is what happens if one partner passes away unexpectedly. Without a clear funding mechanism in place, surviving partners may struggle to buy out the deceased partner’s share, leaving the business vulnerable to disruption or even dissolution. A properly structured buy-sell agreement, funded by life insurance, ensures continuity and protects everyone involved.

Why Use Life Insurance for Buy-Sell Agreements?

A buy-sell agreement sets the legal framework for what happens to an owner’s share of the business in the event of death, disability, or retirement. But while the agreement itself outlines the plan, funding is the critical component. Life insurance provides immediate liquidity at the exact moment it’s needed—when an owner passes away—so surviving partners can purchase the deceased partner’s share without draining company reserves or taking on burdensome debt.

How It Works

Each business partner owns a life insurance policy on the other. If one partner dies, the policy pays a tax-free death benefit to the surviving partners or the business entity (depending on how the agreement is structured). Those funds are then used to buy out the deceased partner’s ownership stake. This allows the surviving partners to retain control of the business while the deceased partner’s family receives fair value for their share.

Case Example

Consider two executives who built a thriving consulting firm. The business was valued at $5 million, with each partner owning 50%. To protect their interests, they established a cross-purchase buy-sell agreement and funded it with life insurance policies. If one partner passes away, the surviving partner immediately receives $2.5 million from the insurance payout, allowing them to buy out the deceased partner’s share without disruption. The deceased partner’s family receives financial security, and the surviving partner continues the business without outside interference.

Benefits of Funding with Life Insurance

• Immediate Liquidity: Provides cash exactly when needed, without relying on business cash flow or outside financing.
• Fair Value: Guarantees heirs receive appropriate compensation for their ownership stake.
• Continuity: Allows surviving partners to maintain control and stability of the business.
• Tax Advantages: Death benefits are typically received income tax-free.

Types of Buy-Sell Agreements

There are several ways to structure a buy-sell agreement:

• Cross-Purchase Agreement: Each partner owns a policy on the other(s). Works well with a small number of owners.
• Entity-Purchase (Stock Redemption): The business owns the policies and buys back the shares. Often used for larger businesses with multiple partners.
• Hybrid Agreement: Combines elements of both structures to meet unique business needs.

Who Should Consider This?

Life insurance-funded buy-sell agreements are critical for privately held businesses, professional practices, and partnerships where ownership transfer can be complicated. If your company has two or more owners, this strategy, as well as a Key Person Policy, should be a priority to protect both the business and your family’s financial future.