Funding purchase of stock from deceased shareholder's estate or heirs with insurance.

• Author: Ellentuck, Albert B.

Facts: The Hawk Corporation, which has a value of $2 million, has only voting common stock outstanding. The corporation is owned equally by Jane, Peter, Mark and Lynn, who are all siblings. Jane and Peter are the original shareholders of the corporation. All shareholders participate in Hawk's daily management and operations. * The shareholders have agreed that a buy-sell agreement should be executed that requires, on the death of one of the shareholders, that either the other shareholders or the corporation purchase the deceased shareholder's stock. Because Hawk's value has substantially increased over the past few years and it has historically experienced cashflow problems, the shareholders are concerned that neither they nor Hawk will have the cash to fund this required purchase. The shareholders want to keep the cost as low as possible became of the cashflow problems and are not concerned the arrangement might benefit one of them more than another. Issue: How can the shareholders ensure funds will be available to purchase a deceased shareholder's stock?

Analysis

Buy-sell agreements can benefit both surviving shareholders and a deceased shareholder's estate, by guaranteeing that stock in a closely held corporation will have buyers and will not be sold to outsiders. The assurance derived from the agreement is meaningless, however, if funds for the purchase are not available. Often, as with the Hawk Corporation, the value of a closely held corporation has increased so much that the remaining shareholders may not be able to fund the purchase of a deceased shareholder's stock. Similarly, the cashflow requirements of a closely held corporation could result in a lack of funds available for the corporation's redemption of the stock or for distribution (as wages or otherwise), to the shareholders to fund their purchase of the stock. One common method of dealing with such funding problems is to purchase insurance on the lives of each of the shareholders.

Assume that the shareholders adopt a cross-purchase form of buy-sell agreement rather than a redemption format. Because the individual shareholders are required by the buy-sell agreement to purchase a decedent's stock, the insurance should be owned and the premiums paid for by the shareholders. The surviving shareholders should be the beneficiaries. Inconsistencies between policy ownership, premium payments, beneficiary designations and the buy-sell agreement can cause problems. (For example, if...