Is Your Business’s Buy-Sell Agreement Fully Funded?
By Preston Rosamond
Often, just keeping the lights on when you’re running your own business takes up all your time. Still, you must take the time to plan for the day you no longer can manage the business, or wish to exit for some other reason. This planning becomes more complicated, and also more vital, when you have business partners. We frequently work with business owners and encourage them to have a buy-sell agreement in place. Learn how this agreement can protect your business and your options for funding it.
Basics Of A Buy-Sell Agreement
Many businesses create a buy-sell agreement that specifies what happens to a partner’s share of the business if the partner dies or otherwise leaves the firm. Usually, a buy-sell agreement stipulates that the partner sells their stake back to the partners instead of to an outside party. Still, the remaining partners must have the funds available to be able to buy out the stake of the other partner when they need to. If not, the business may pass to heirs who are unwilling or unable to operate the business. Here are some options to ensure your buy-sell agreement is fully funded if you need to activate it.
How To Fund Your Business’s Buy-Sell Agreement
There are several ways to finance your buy-sell agreement. Here’s an overview of some of the most popular and what to keep in mind as you consider each.
Life insurance: Life insurance can provide cash to buy out partners if one passes away. Typically, the business can own policies on the owners, or each owner of the business buys a life insurance policy on the other owners. If one of the other owners dies, the survivor(s) then use the life insurance proceeds to buy their stake in the company. Some life insurance companies sell policies specifically for buy-sell agreements.
Sinking fund: With a sinking fund, the business regularly contributes a portion of after-tax profits to a fund that can be used to buy out a partner. A sinking fund provides immediate liquidity, though unfortunately, the amount set aside is often insufficient if the company is fairly young and/or the death or exit of the partner is unexpected. Also, funds kept in a sinking fund aren’t available for other business uses.
Installment payments: Using installment payments, the current partners can buy out another partner’s share over time, using after-tax profits from the business. This method has the advantage of giving the remaining partners time to raise the money for the buyout. Still, it’s possible that the company’s profits won’t be enough to make the installment payments, and that there could be control issues in the business between heirs and remaining partners during the gradual transition.
Borrowing: The remaining partners could borrow money to buy out the stake. Relying on a loan frees the business from the expense of life insurance premiums or the need to save into a sinking fund. Still, applying for a loan may be difficult for a company that just lost a key member, and it adds interest cost to the price of the buyout.
Professional Advice And Your Business
Being a business owner means that you’re swamped with day-to-day operations. Still, buy-sell agreements and other parts of succession planning often aren’t urgent until the unexpected happens. Working with a financial advisor familiar with small businesses can help you stay on top of contingencies. We can help you create a financial plan that incorporates your personal situation and that of your business. We can also ensure your buy-sell agreement and other important documents are up to date and tailored to your unique situation. I offer a complimentary introductory meeting if you’re interested. Call my office at 830-798-9400 or email email@example.com.
Preston Rosamond is a financial advisor and the founder of The Rosamond Financial Group Wealth Management, LLC with nearly two decades of industry experience. He provides comprehensive wealth management and financial services to individuals, professionals, and families who enjoy simplicity and seek a professional to help them pursue their goals. Preston personally serves his clients with an individual touch and a sincere heart, and his servant’s attitude is evident from the moment you meet him. Learn more about Preston or start the conversation about your finances with him by emailing firstname.lastname@example.org or schedule a call with our online calendar.