Life Insurance Proceeds in Valuation for Buy-Sell Agreements
Many buy-sell agreements are funded, in whole or in part, by life insurance on the lives of individual shareholders, who may be key managers, as well. Life insurance is a tidy solution for funding when it is available and affordable. It is important, however, to think through the implications of life insurance from a valuation perspective whether you are a valuation expert, a business owner or both.
The proceeds of a life insurance policy owned by a company naturally flow to the company. Should life insurance proceeds resulting from the death of a shareholder be considered as a corporate asset solely for the purposes of funding the repurchase liability created by a buy-sell agreement? Alternatively, should the life insurance proceeds could be considered as a separate corporate asset, i.e., as a non-operating asset, to be included in the calculation of value for the deceased shareholder's shares?
This decision as to the treatment for any particular buy-sell agreement is one that warrants discussion and agreement. Absent specific instructions in a buy-sell agreement, appraisers) may have to decide how life insurance proceeds are to be considered in their determination(s) of value. What they decide will almost certainly disappoint at least one side and may surprise both.
Two potential treatments of life insurance proceeds are noted above. Let's consider them specifically, and then look at examples of their treatment and the differing impacts that the treatments have on all parties to a buy-sell agreement, including the selling shareholder, the remaining shareholders), and the company.
- Treatment 1 - Proceeds are a Funding Vehicle. This first treatment would not consider the life insurance proceeds as a separate, non-operating corporate asset for valuation purposes. This treatment would recognize that life insurance was purchased on the lives of shareholders for the specific purpose of funding the liability created by the operation of a buy-sell agreement. Under this treatment, life insurance proceeds, if considered as an asset in 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.