Life rarely goes according to plan. An unexpected death, disability, divorce, or another event can derail a business and create a huge financial impact on its success. Your business is likely your biggest investment and the future resource for funding your retirement.
All businesses should prepare for a multitude of issues that could put the future of the business in danger. For instance, who would manage/own the business upon retirement or unexpected death/disability of an owner? Is there an internal candidate who is experienced enough to manage the business, or would the business need to be sold to an outside competitor? What about your family’s needs regarding the business?
A buy-sell agreement is an excellent solution to this risk. It is simply a “will” for how you want the business to transition on Your Terms based on certain triggers such as retirement, death or disability.
There are options for funding a buy-sell agreement, but some options open the door to other problems.
- A company savings account would pay cash when an owner dies, but if death unexpectedly occurs, there may not be enough funds in the account to carry the business.
- A loan could be obtained at the time. Unfortunately, interest could be high and it may create unnecessary risks for the surviving owners and business.
The best option to fund a buy-sell agreement is a life or disability insurance policy. These types of policies allow for instant cash/liquidity to be used in either continuing the business or preventing a fire sale, allowing proper time for a buyer to be found. Other advantages include: death benefits proceeds are generally income tax free, funds are purchased for pennies on the dollar, and premiums are likely to be significantly lower than loan interest.
Life insurance also offers the option of a Cross-Purchase Plan or an Entity Plan. In a Cross Purchase Plan, each owner purchases a life insurance policy on all other owners and is named beneficiary. In an Entity Plan the business purchases a life insurance policy on each owner and is named beneficiary of plan allowing the business to buy shares stock redemption style, preventing other owners from paying out of pocket.
Both a Cross Purchase Plan and an Entity Plan offers flexibility such as:
- Price fixing, formula, or appraisal (most important! Establish fair market value of stock or business at time of agreement.)
- Pay in cash or installment.
- Different terms for different events (different prices for retirement, death, disability, etc).
Having a buy-sell agreement is imperative. Preparing one in advance eases negotiations and agreements as no one is sure what the next day will bring.