The two basic types of buy-sell agreements are:
Though the client's attorney will recommend which type of plan is most appropriate, this discussion provides some useful background.
Note: For simplicity, we will assume that the triggering event in each case is death.
Cross-purchase plans
Under a cross-purchase plan, the principals agree to buy each other's interests in the business if one of them dies; the deceased's estate is required to sell at the agreed-upon price.
To fund the agreement with life insurance, each owner owns, pays for, and is beneficiary of insurance on the lives of the other owners. The amount of insurance purchased is based on each owner's proportionate share of the business.
The situation illustrated here is a partnership, but a corporate cross-purchase agreement works roughly the same way.
Example: A, B and C, equal partners in a business worth $900,000, adopt a cross-purchase agreement. Each partner will buy $150,000 insurance on the lives of the other two owners. Six policies will be needed.
As shown here, if B dies, A and C will each use the $150,000 death proceeds to buy 50 percent of B's one-third of the business. B's estate receives $300,000, the value of B's ownership interest. A and C each receive a "stepped-up" basis in the stock they purchased from B's estate.
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