Buy-sell agreements are no better than their funding mechanisms, which are necessary to ensure workability from the viewpoints of both future buyers and sellers. Many buy-sell agreements are funded with life insurance. What is not found in many of these agreements is how the life insurance proceeds should be treated – are they corporate assets or are they not?

Proceeds Are Not a Business Asset. One treatment would not consider the life insurance proceeds as a corporate asset for business valuation purposes. This treatment would recognize that life insurance is purchased on the lives of shareholders for the specific purpose of funding a buy-sell agreement. Under this treatment, life insurance proceeds, if considered as an asset in business valuation, would be offset by the company’s liability to fund the purchase of shares. Logically, under this treatment, the expense of life insurance premiums on a deceased shareholder would be added back into income as a non-recurring expense in the business valuation.

Proceeds Are a Corporate Asset. Another treatment would consider life insurance proceeds as a corporate asset for valuation purposes. In the business valuation, the proceeds would be treated as a non-operating asset of the company. This asset, together with all other net assets of the business, would be available to fund the purchase of shares of a deceased shareholder. Again, under this treatment, the expense of life insurance premiums on a deceased shareholder would be added back into income as a non-recurring expense in the business valuation. The choice of treatment of life insurance proceeds can have a significant, if not dramatic, effect on the resulting position of a company following the receipt of life insurance proceeds and the repurchase of shares of a deceased shareholder. The choice of treatment also has an impact on the resulting position of any remaining shareholders.

If you have a process buy-sell agreement funded by life insurance, the amount to be paid for the stock is likely uncertain. Issues related to the treatment of life insurance have suddenly become more important. If you have such an agreement, we strongly urge you to review it promptly to be certain that valuation-related issues will not arise.