Business owners are in a unique planning situation. Not only do businesses provide income for the owner, but the business itself can grow to become a very valuable asset. The planning on how to turn this asset into something that the owner and owner’s family can use to fund their financial goals, however, can be a very complex process.

One aspect of this planning process that should be considered is what would happen to the business and the ownership interest if an unexpected event were to happen. The death or disability of the business could have a catastrophic impact on the value of the business. We have listed below several key considerations business owners should make to contingent plans if such an event were to occur.

Defining the Succession Plan

Establishing the guidelines for how and when the business ownership transfers should be one of the first considerations made. Defining the “triggering events” such as death, disability, or any other item that would trigger the transfer of ownership should be clearly defined.

In the case of one of these “triggering events” happening, how will the business be valued? Will the business partners agree on a value, will a third party valuation company be used?

Additionally, how would ownership transfer and to whom? Should ownership interest be split among partners equally, should there be limitations on any ownership interests, voting rights, etc.?

Finally, once these terms have been defined, a strategy on how to fund this business transfer should be considered.

Funding of Business Transfer

Once there is an initial outline of a succession plan, an owner should next consider the financial aspect of the ownership transfer. Each business and business owner has their own very unique needs and goals, which in turn requires a unique planning strategy for each situation. The size of the business, how many business owners there are, if the business is family owned and other business structure concerns can impact the proper planning strategy.

Ideally, the owner can structure a deal so that the successor business owner(s) are able buy the ownership interest from the owner, the owner’s decedents or owner’s estate. This sale would provide funds to the owner, owners family, and/or estate and would effectively transfer the ownership interest to the pre-determined parties that will actually run the business going forward.  Depending on the value of the business, the ownership interest may be large enough that the remaining owner(s) may not have the capital to purchase this interest.

There are solutions to this funding problem; for example, taking a loan out to buy the ownership interest back.  The main issue with funding this plan through a loan are the interest costs, and the potential inability to access capital due to market conditions.  Additionally lenders may be reticent to provide the loan because of the fact that there has been a major disruption in the business. One strategy to help solve this funding problem is to take out life insurance policies out on the business owners. If an owner were to pass away, the death benefit paid out would allow the remaining owner(s) to have the funds necessary to purchase back the deceased’s ownership interest.

As with most planning topics, there is no one solution for how to set up this life insurance arrangement. Two common structures however are a Cross Purchase Plan, where each owner owns a policy on all of the other owners, and an Entity Purchase Plan, where the business itself owns a life insurance policy on each owner and then distributes the appropriate share of the death benefit to the remaining owners(s). How large the company is/how many owners there are can be a key component of deciding which strategy would be best. The Entity Purchase Plan can minimize the number of policies that are taken out and can be less cumbersome when a business has a larger number of owners, while the Cross Purchase Plan can be a simplified arrangement if there are only two partners. Both of these structures have tax consequences that need to be factored in the decision making process.

There are many key considerations regarding what succession plan arrangement may be best for a business owner. We have highlighted a few high level considerations. Every business owner’s situation is unique, and we recommend working with a specialist to develop a plan that meets your unique needs.


–Brett Spencer MS CFP®