By Boyce F. Lowery, CLU, ChFC
If you are like most business owners, a short list of things that are important to you would certainly include your business and your family. If anything happens to you, you want to make sure that your business and your family are secure. We all know that life is full of uncertainties, so having a solid buy-sell agreement in place for your business is important planning for both your business and your family.
A well drafted and fully funded buy-sell agreement will allow for business continuity, ensuring that your departure doesn’t cause unnecessary disruptions or financial difficulty. It will also provide for your family financially so that they will not suffer from your loss financially speaking. Yes, a buy-sell agreement is essential for any forward-thinking business owner, but the quality of the agreement itself has a large impact on its efficacy. Here are just three elements of a good buy-sell agreement. There are certainly other important considerations as well.
What is your company worth? What will it be worth in future years when one of your partners decides to retire or otherwise leaves the company? What about when you retire? Of course, there are many ways to value a company. Some enterprises utilize a custom formula to determine the business value at any given moment in time. Others set a specified value for the company at present with regular, periodic reviews where the value is to be updated through agreement of the partners. Still, others employ professionals to provide a valuation.
More important than the valuation methodology that you choose is that all parties are in agreement. Not just for the present valuation, your chosen valuation method must also satisfy everyone no matter when ownership is transferred, whether next year or in future years. Agreement on valuation methodology is vital to a successful buy-sell agreement. An owner doesn’t want his/her family to be left high and dry while partners argue over how much the business is worth. Nor do the remaining partners want their business embroiled in a legal battle.
What events is your buy-sell agreement designed to address? Most people think of retirement and death as the things that would trigger a buy-sell agreement. But what about a pending divorce, long-term disability of a partner, a pending bankruptcy or judgement against a partner?
When drafting a buy-sell agreement, it is crucial to think through the possible scenarios. An adequate buy-sell agreement considers all possible contingencies and has a plan for each so that the company and its owners are prepared for whatever may come.
Once you establish a valuation methodology and determine the potential triggering events, you need to answer the question of where the money will come from for the various triggering events should one occur. There are a number of options available, depending on which triggering event is being planned. Those options can include life insurance, disability buy-out insurance, a company sinking fund, bank financing, or a promissory note to be paid from ongoing operations. It is important to understand that any funds paid from company earnings are “after-tax” which can certainly be a severe financial strain on the company and jeopardize both the company and the partner or estate of the partner from a financial perspective.
By far, the most popular funding option for buy-sell agreements is life insurance. Unlike a promissory note, life insurance provides immediate tax-free liquid funds at the time of loss when the money is needed. While a life insurance policy doesn’t pay out its death benefit for a retiring partner, with the right kind of policy, funds can certainly be available to either provide a retirement income to the departing partner and/or to make a down payment on the amount owed.
If you are developing a buy-sell agreement for your business, we can help. With decades of experience in the life insurance industry specializing in the planning needs of business owners, we have developed funding options for countless buy-sell agreements. A buy-sell agreement could very well determine your business’ financial future and/or your family’s financial future, so you want to make sure it’s done correctly. You’ll want to make sure that all of your partners agree on a valuation methodology and on how to handle the various triggering events. Because of the many buy-sell agreements we’ve seen through the years that are woefully inadequate, we strongly advise that you work with a seasoned professional who can help you think through all the relevant issues, including tax issues. For a free and confidential consultation, call us at 888-827-0146.
Boyce Lowery is a 40-year veteran and established expert in the insurance industry. As the managing partner of Suncrest Advisors, he, his partner, and their associates all aim to provide financial security and peace of mind to business owners, executives and professionals, and high net-worth individuals across the United States. Along with more than four decades of experience, Boyce is a Chartered Life Underwriter® (the premier designation for insurance professionals signifying specialized knowledge in life insurance and estate planning) and a Chartered Financial Consultant® (known as the advanced financial planning designation). To learn more, visit https://suncrestadvisors.com/ or connect with Boyce on LinkedIn.