In a previous post, I explained how to use a cross-purchase plan to transfer business interests among partners/owners using life insurance policies. The cross-purchase plan is most effective for businesses with relatively few owners. It can be great for commercial real estate brokerages or real estate investment partnerships that have two or three owners.
But the fundamental problem with a cross-purchase plan is the number of insurance policies that they require. As the number of owners increases, the number of life insurance policies needed also increases. With two owners, it requires just two policies. With three owners, it requires six policies. With ten owners, it requires 90 policies. This is because each owner has to have life insurance policies on every other owner. It can get complicated quickly.
If your real estate brokerage or real estate partnership has many owners, a cross-purchase plan may not be effective.
This is where the entity purchase plan comes in.
With an entity purchase plan, the business (as its own entity, separate from the individual owners) agrees to buy the business interest of each owner in the event of death, disability, or retirement.
Using life insurance is one way to fund the buy-out of one of the owners, especially in the event of that owner’s death or disability.
Life Insurance Is Key to an Entity Purchase Plan
When I wrote about cross-purchase plans, I used a simple two-owner business to illustrate it. Here’s the beauty of an entity purchase plan: it doesn’t matter how may owners there are.
In an entity purchase plan, the company buys insurance policies on the owners and uses the death benefit proceeds to buy back ownership proceeds upon the death of a partner. With three owners, it requires three policies. With ten owners, it requires 10 policies. This is because the business has to have life insurance policies on each owner.
Contrast that with a cross-purchase plan. With three owners, it requires six policies. With 10 owners, it requires 90 policies. An entity purchase plan reduces complexity regarding life insurance policies.
If one of the owners dies, their interest in the business will pass to their estate or their family by the terms of their will or, if they don’t have a will (which is a really bad idea!), by the laws or probate. This is where the insurance comes in.
Benefits of an Entity Purchase Plan
The business as an entity–not the individual surviving owners–uses the insurance proceeds to buy the deceased owner’s interest from the surviving owner’s family. This returns the deceased owner’s share to the business as a whole. Therefore, each surviving owner owns a greater share of the business.
Other Points to Consider
The surviving owners will not receive a step-up in basis for the shares of the business, so they will have gains in the eventual sale of the business.
As fiduciary financial planners, we at Dominion Financial Advisors do not sell life insurance. But we can recommend insurance agents and insurance plans that fit within your overall financial plan to help ensure that your plan works as intended. Insurance isn’t a separate idea–it’s a key part of a cohesive financial plan. Helping you to create and manage a cohesive financial plan is where we come in.
As a registered investment adviser (RIA) firm, we are legally and ethically required to act as a fiduciary at all times. That means we always must act in your best interest. We have the duty to be loyal to you and to act with care, skill, prudence, and diligence.
If you think our values align with your values, then schedule a consultation or contact us to find out how we can help you with financial planning and wealth management.