Most small business owners have a considerable portion of their net worth tied up in their business. In terms of personal and family financial security, the "What happens if the principal becomes disabled or dies?" is of paramount importance.

In a "one-man band" operation, the primary concerns are providing income for surviving family members, and funds to cover estate settlement costs in the case of death. In such cases (typically sole proprietorships), the business will usually cease upon the long-term disability or death of the owner. For this type of business, adequate protection may be achieved with life and disability insurance matched to the projected needs of the survivors.

In contrast, consider the example of a small law firm owned by four owners, one of whom recently died leaving his interest to his spouse. The surviving spouse has personal income needs and wishes to sell her deceased husband's share of the business; the surviving owners are concerned that the former owner's share may fall into an outsider's hands. How can both parties satisfy their needs fairly?

Enter Buy-Sell Agreements
For any business owned by more than one person, buy-sell agreements triggered by disability or death protect both the disabled/deceased owner's interest and the interests of the remaining owners. Simply stated, a buy-sell agreement establishes the conditions under which one owner (or owners) would buy and one owner (or that owner's estate in the event of death) would sell shares of the business.

In many multi-owner businesses (small partnerships, closely-held C or S corporations, limited liability companies), personal protection concerns extend beyond the desire of the surviving partners to continue the business (in the event of disability or death) to include arrangements for a planned, voluntary withdrawal by an owner from the business (e.g., retirement).

In situations in which saving for retirement has been difficult, it is common for owners to view their shares of the business as equity for retirement. Many small multi-owner businesses include retirement in their buy-sell agreements as a way to liquidate a retiring owner's share on a pre-established, equitable basis.

Buy-sell agreements are typically structured as either cross-purchase or entity purchase plans. In a cross-purchase agreement, each owner agrees to purchase another owner's interest in the business upon the occurrence of a qualifying event. In an entity purchase agreement, the business entity purchases the stock of the disabled/deceased/retiring owner. There are advantages and disadvantages associated with each plan, but one common thread running through many buy-sell agreements is the use of life insurance to help ensure that sufficient liquidity will be available when a death brings about the sale of an ownership interest.

Survivorship Life Insurance
Consider the example of a closely-held business run by a husband and wife, with a succession plan calling for passing ownership of the business to their daughter upon the death of the second parent. The existing estate plan utilizes the unlimited marital deduction at the first death, meaning all assets (including business interests) would pass to the surviving spouse with no federal estate tax burden at the first death.

A significant liquidity problem could arise at the death of the second spouse. If most of the remaining family wealth is tied up in the family business, how could it pass intact to the daughter? One solution to this question might be a survivorship life insurance policy, which would provide a death benefit when the second named insured dies. In this example, since the potential estate tax burden is deferred until the second death, a survivorship policy could provide liquidity precisely when it is needed most.

Since no death benefit is paid at the first death, survivorship life may be most appropriate when the surviving spouse has sufficient income from other sources. Income needs for the surviving spouse must be weighed against liquidity needs at the second death. If income needs for the surviving spouse are greater than funds available, it is suggested that two individual life policies be purchased by the husband and wife (co-owners of the business) with each policy naming the other spouse as beneficiary. This way the two policies will provide the additional funds needed at the time of one of the spouse's (co-owner's) death.