ven though it’s more pleasant to think of retirement or a career change as the reason for an owner’s exit,
the death of an agency shareholder is a real possibility. As a result, every insurance agency needs to have a written perpetuation plan and properly crafted buy-sell agreements, especially if there is more than one agency owner.
A Buy-Sell Agreement is also known as a Shareholders’ Agreement, a Members’ Agreement, or a Partners’ Agreement depending on the type of entity. Regardless of what it’s called, the agreement should address death, among other triggering events. Structuring the insurance agency incorrectly can cost the surviving shareholders significant money. Below are some key considerations agency owners should make when preparing a perpetuation plan in the event of a death.
Classifications of Stock What percentage of the agency do you own? Surprisingly, many people answer incorrectly because they don’t understand different stock classifications:
Authorized: When a business incorporates, the Articles of Incorporation state the number of shares authorized: the maximum number of shares the business can issue without amending the Articles of Incorporation.
Issued: The corporation issues stock to shareholders. While the number of shares issued can equal the number of shares authorized, it is usually a good idea to leave some shares authorized but unissued in case the corporation wants to issue additional shares in the future.
Treasury Stock: Issued shares the corporation has bought back from shareholders. They can be reissued in the future, just like authorized but unissued shares.
Outstanding Stock: Outstanding stock equals the issued stock minus any treasury stock.
A shareholder’s ownership percentage is equal to the number of shares the shareholder owns divided by the total outstanding stock.
Example: Bob, Joe and Fred start an agency from scratch, and the articles of incorporation authorize 10,000 shares. The corporation issues 500 shares to each of the three partners (1,500 total shares issued) each of whom owns one third of the agency. A few years later Fred retires and the corporation buys back Fred’s shares. The status of the stock at this point is:
Authorized:
Issued & Outstanding: Treasury Stock:
10,000 1,000 500
Bob and Joe still each own 500 shares but now they each own 50% of the corporation since treasury stock is not factored into percentage ownership.
Life Insurance Ownership Depending on how you have structured your Shareholders Agreement and Life Insurance, you either have a stock redemption or a cross-purchase agreement.
Stock Redemption: The corporation owns the policies, is the beneficiary of the proceeds, and uses those proceeds to buy back the stock of the deceased from the estate of the deceased. This stock then becomes treasury stock.
Example: A corporation is worth $2 million and has a $1 million life insurance policy on Bob and a $1 million policy on Joe. Joe dies. The $1 million life insurance proceeds go to the agency which then pays the $1 million to Joe’s estate. Joe’s 500 shares now become treasury stock. Although Bob still owns 500 shares, he now owns 100% of the agency since treasury stock is not outstanding. A few years go by and Bob sells the agency for $3 million. The entire $3 million is taxable.
Cross Purchase: In a cross purchase situation, the shareholders (not the corporation) own the policies on