If you own a business or part of a business any business you need a buy-sell agreement. If something happens to you, a partner, or a stockholder, do you have a plan in place for the future of your business?
In my 20 years in the financial services industry I've seen the myriad of ways not having a properly funded buy-sell agreement has wreaked havoc not only on the business entity but on the parties involved as well. I'd like to share with you the top mistakes I've experienced as a business owner and as a consultant to others concerning buy-sell agreements.
* I'm a sole proprietorship. I don't need one. So what will happen to your business if something happens to you? Your executor or heirs could try to run the business. Are they willing and qualified? Is there additional cash to provide a smooth transition? I'm sure creditors will still want to be paid. Is there enough cash to settle the estate? So, the next option would be to sell the business as a going concern. Do you have a buyer? Will your family get fair market value? And again, creditors still want payment. Most times the assets of the business are liquidated at a fraction of the cost. Not to mention the loss of income to your family, employees being laid off, and the community may lose an important part of its economic life.
This all sounds pretty rough. But, a properly executed buy-sell agreement funded with life insurance between the owner and a key employee could be the solution you need to ensure that your heirs will be taken care of and your business will continue on if you are gone.
This type of agreement assures that your heirs will receive fair market value for your business, rather than having a forced liquidation sale. It also ensures your valued employee will have full control of the business decisions and that employment and business income will continue.
* We have an agreement but have not funded it, or we have insurance but no agreement. I'll start by saying any agreement is better than none. The most important and most obvious part of any agreement is the price. The price might be paid in cash or installments over time depending on the circumstance. There can be different terms for different events, one price and terms for retirement, one for disability, and one for death. The price might be fixed, determined by appraisal or a formula. If you have one without the other you might as well have nothing. Would you like to be in business with your former partner's spouse? Do you like litigation? If so, great. If not, get the agreement done.
The neat thing about buy-sell agreements is that they are reciprocal. Meaning, what's good for the goose is good for the gander. No one knows if you or your partner will be the first to go by death, disability, retirement, etc. That reciprocal nature makes negotiating and agreeing on these issues easier than you might think.
* Funding. Insurance features prominently in many buy-sell agreements. You don't have to use insurance, but it can ensure there's cash available when the time comes. The majority of agreements that I have reviewed over the past few years have been funded with term insurance. It's cheap and in this economy business owners are looking for savings. But is that the best vehicle possible for the need? The reason term insurance is so cheap is that only 2 percent of policy owners actually receive a death benefit. Do you think you will still be alive in 20 years? I do. If that's the case then new policies will have to be issued to keep your agreement funded with the premium's increasing exponentially. (Very expensive).
Whole life may be a viable alternative. Whole life is more expensive when the policy is issued but as you age the cost decreases compared with a term policy as the premium is guaranteed for life along with the death benefit. Thus, the term,"whole life." In addition the whole life policy generates a dividend and has a cash account. This could be used as emergency funds or collateral. At the end of the day, the cheapest option may not be the best option. Review your options.
* Get some help. You'll need a business attorney experienced in buy-sell agreements to help you choose the right type and draft it. Consult your CPA. And just as important, consult your financial advisor to discuss funding options. There are great resources available to you, use them. This may be the best money you have ever spent.
And remember, any agreement and funding vehicles must be integrated into the overall plan and objectives of the business. So take the time and look at your options. Proper planning now can save big headaches latter on.
Emitt Samon is a financial representative with Country Financial in Reno. Contact him at 775-829-1011 or Emitt.Samon@countryfinancial.com.
