Key-person risk and buy-sell agreements: insuring a funeral home’s continuity

Most businesses can limp along for a few weeks after an owner dies. A funeral home cannot. The phone rings the next morning, a licensed person must supervise every arrangement, and the regulator starts a clock on the establishment license. Families in town will also notice within days whether the firm still feels steady.

A funded buy-sell agreement and a key-person policy are how owners plan for that morning while everyone is healthy. This guide covers how to structure and fund them. If owners already disagree, our guide for siblings or partners in conflict is the better page; if a death has already happened, start with what to do after an owner’s death or incapacity.

What does a funeral home buy-sell agreement actually do?

It turns a future crisis into a contract: who buys, at what price, with what money, and how fast. The agreement names the triggering events and binds the owners, the company, and each owner’s estate.

For a funeral home, two triggers deserve more attention than in an ordinary company. Loss of license matters because many states limit who may own or operate an establishment, so an owner whose license lapses may not be able to keep shares. Disability matters because a licensed owner who cannot work nights or direct services is still drawing on the business while someone else carries the call schedule. Spell out how disability is determined and how long it must last.

Should the funeral home or the owners own the life insurance?

Each structure works, but the 2024 Supreme Court decision in Connelly changed the trade-off. When the company owns the policies, the proceeds can increase the deceased owner’s estate tax value.

In Connelly v. United States, decided June 6, 2024 by a unanimous Court, two brothers’ company held $3.5 million of life insurance on each to redeem shares. The IRS valued the company at $6.86 million, counting $3 million of proceeds, not the $3.86 million the estate reported. The deceased brother’s 77.18% stake was valued at about $5.3 million instead of $3 million, and the estate owed an additional $889,914. The Court held that the redemption obligation did not offset the insurance proceeds. It also noted that a cross-purchase agreement would have avoided the result.

With more than three owners, the policy count in a cross-purchase grows quickly, so some families use an LLC or trust that holds one policy per owner. That variation needs careful drafting; ask your attorney before you choose it.

Why insure the funeral director in charge separately?

Because the business, not the family, bears the cost of losing its licensed leader. A key-person policy pays the company cash to bridge the months until a replacement is recruited and trusted.

In many family firms the funeral director in charge is also the face of the firm at every arrangement. Our guide to reducing owner dependence explains why that concentration lowers value; key-person insurance is the backstop while you build the bench.

The tax rules are strict. Under 26 U.S.C. § 101(j), the income-tax exclusion for an employer-owned policy is capped at the premiums paid unless, before the policy is issued, the insured is told in writing that the employer intends to insure them, the maximum face amount, and that the employer will be a beneficiary, and gives written consent. The IRS also expects an annual report on Form 8925 for employer-owned contracts issued after August 17, 2006. Missing the consent form before issuance is a mistake that cannot be fixed later.

To see what each owner’s share is worth today, the seller’s discretionary earnings definition explains the earnings base most buyers use for single-location firms.

Why do buy-sell valuation formulas go stale?

Because funeral home values move with call volume, cremation mix, preneed funding, and buyer appetite, while a number typed into a 2014 agreement does not. A stale price either robs the estate or burdens the survivor.

The common failures we see are a fixed dollar price nobody updated, a book-value formula that ignores goodwill, a revenue multiple that ignores margin, and a formula silent on the real estate and on a preneed trust shortfall. Connelly adds another: the brothers’ agreement called for an outside appraisal, and they agreed a figure instead.

Federal tax law adds a test. Under 26 U.S.C. § 2703, a buy-sell price is generally disregarded for estate and gift tax unless the agreement is a bona fide business arrangement, is not a device to transfer value to family for less than full consideration, and has terms comparable to arm’s-length deals. A friendly family price can fail.

Better options:

1. Annual certificate of value. Owners sign a value each year, with a fallback to appraisal if no certificate is less than about two years old.
2. Appraisal at the trigger. Name the standard of value, the valuation date, the treatment of minority discounts, and how the building is handled.
3. Formula with an appraisal cap or floor. Useful when owners want predictability but need a check against drift.

Our guide to valuations for estate, gift, and divorce purposes covers standards and discounts, and our comparison of a certified appraisal versus a broker’s opinion explains which report each option needs.

What license deadlines start when an owner dies?

Often within days, and they vary by state. The buy-sell has to close inside the window the regulator allows.

Maryland is a clear example. Under Health Occupations § 7-308.1, the personal representative of a deceased licensee’s estate must apply for an executor license within 30 days of the death and, within 14 days, name a licensee who will apply for a preneed trustee license. The executor license lasts no more than 12 months, with one 3-month renewal available if a buyer is already under contract. The Maryland state page covers the rest of the state’s rules.

Insurance proceeds usually arrive within weeks of a claim, which is why a funded agreement fits these clocks and an unfunded one rarely does.

How do buyers and lenders view an insured continuity plan?

Favorably, because it shows the firm will still be there after a death. It does not raise the price by itself, but it removes a reason to discount it.

Buyers read the buy-sell in diligence for rights of first refusal or consent rights that could block their deal. Acquisition lenders, in our experience, often ask for a collateral assignment of life insurance on the principal borrower. When the firm is sold, the agreement usually ends at closing.

The valuation hub links the other pages owners use to keep that number current. Review the agreement, the policies, and the tax treatment with your attorney and CPA before you sign or change anything.