In today's business environment, it's sometimes easy to overlook even simple planning mistakes. Yet, when it comes to the succession of your law firm, there is one tool that should always be in place - a buy/sell agreement.
For those who are in practice with one or more attorney partners, the untimely passing of one key person could cause significant financial hardship for the entire firm. Because there is typically no market for the ownership interest in a closely held business, a buy/sell agreement can be crucial for the firm's ultimate survival.
In many ways, a buy/sell agreement can be considered your law firm's "pre-nup" agreement because it can literally lay out exactly how the firm will deal with unexpected and unforeseen events should they occur.
Some of the primary reasons that attorneys in particular should consider having a buy/sell agreement include:
1. Instant Liquidity to Fund Current Partners' Purchase
Should one of the attorney partners pass away, the insurance proceeds can help to provide the needed funds for the remaining partners to purchase the decedent's portion of the firm. By using term life insurance to fund a buy/sell agreement, each attorney partner purchases a policy on the other partners.
This "instant liquidity" can allow each of the other partners to come up with the funds for purchase without the need to liquidate other assets such as retirement funds, home equity, or personal savings. In addition, the funds are also advantaged from a tax standpoint, as life insurance proceeds are typically received free from income taxation.
2. Keeping the Firm in Operation
The funds from a buy/sell agreement funded with life insurance could also be used for continuing the operation of the firm during a time of transition. With the passing of a key attorney in the firm, it is likely that a large chunk of revenue will also be lost. Therefore, the proceeds from a life insurance funded buy/sell agreement could help to get the firm over the hurdle until replacement revenue begins to come back in the doors again.
3. Barring Strangers from Becoming Your New Business Partner
One of the biggest reasons to have a buy/sell agreement in place is to ensure that you know who your potential future business partners will be. Because each of the firm's partners purchases a life insurance policy on the others, it is known in advance who will be purchasing any of the other partners' interests. Knowing in advance that the partnership will remain for the most part stable can also be reassuring to the other employees, as well as the clients, of the firm.
As an additional benefit, a buy/sell agreement can oftentimes provide a mechanism for resolving business disputes, as it assures that no single owner or partner holds 100% of the firm's control.
4. Protecting Your Spouse and Other Survivors
The spouse or other survivors of a deceased partner may also have use of the cash from the life insurance policy proceeds. This is because a buy/sell agreement that is set up using life insurance could help family members and other heirs of the business owner to be assured that funds will be available for a number of different reasons.
First and foremost, your survivors will likely want to be assured that there will be money available for the other owners or partners in the firm to purchase your share of the business, and in so doing, funneling those funds on to the estate and replacing income that your survivors will no longer receive from the business.
If your share of the business will not be sold to the remaining owners or partners (for instance, if you are a solo practitioner), survivors may still need some way to keep the business operational until a suitable buyer can be found or until cases are closed and operations are shut down. Life insurance proceeds can provide the necessary funding for this situation as well.
The Bottom Line
Because all law firms are different, the buy/sell agreement that you use should be as closely tailored as possible to your business's needs. Typically, term life insurance is the best way to go about funding a buy/sell agreement, as it can often provide this necessary temporary coverage at a relatively low premium cost.
In any case, because nobody knows what will happen in the near or long-term, a buy/sell agreement should be created as soon as possible to the inception of your firm. This way, you can be aptly covered right from the start.
Liran Hirschkorn is an independent life insurance agent. His mission is to help individuals across the U.S in finding the best rates on life insurance as well as helping those that have previously been declined get approved for coverage.