Funding a Buy-Sell Agreement
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Before we dive into funding a buy-sell agreement, it’s important to be aware of how business owners use life insurance in their succession plans. In addition to buy-sell agreements, there are several important ways life insurance is used in a business which we will discuss in detail in future posts such as:
- Buy-Sell Agreements (this article)
- Key Person Protection
- Attraction & Retention Programs
- Company-Owned Life Insurance (COLI)
- Securing or Refinancing of Small Business Administration (SBA) Loans
Buy-Sell Funding Solution
You can create your buy-sell funding plan, and buy life insurance for each owner in 10 minutes or less! No need to wait to speak to an agent, you got this!
What is a Buy-Sell Agreement?
A buy-sell agreement is a legal document detailing how the sale or purchase of an owner’s interest in a business will work upon a triggering event. Triggering events often include the sale of a business, or the death, disability, or retirement of an owner. The death of an owner or key partner is the most commonly recognized triggering event for a buy-sell agreement.
A buy-sell agreement will define who gets what share of the business and for how much, and guarantees the buyer a predetermined price based on a company valuation. This means the business or remaining business owners have a consistent way of buying out a partner who has a triggering event. Another benefit of having a buy-sell agreement is creditors will likely be easier to work with when they see a business has the proper protection in place to make loan decisions easier.
The buy-sell agreement can be drafted by business partners/owners, but you should consider having an attorney draft a buy-sell agreement and have your business valuation reviewed by or provided by your CPA or a professional valuation service. In our Buy-Sell Process, we provide the ability to have the structure and valuation completed within minutes. Once you have the agreement, valuation, and structure in place, the next step is funding the agreement with life insurance. Our Buy-Sell process also allows for an instant and seamless application process for all owners.
Four Ways to Fund a Buy-Sell Agreement
Below are the four most common ways business owners fund buy-sell agreements:
- Life Insurance: Life insurance payout will be available and distributed exactly the way the co-owners intended to ensure the future success of the business. The life insurance company will require details of the buy-sell agreement when your financial professional submits the application.
- Take out a loan: Loans can be used to purchase the business upon the death of the owner or partner. This requires borrowing the purchase price while using future business profits to repay the loan and any associated interest.
- Installments: Sometimes installment purchase plans are put in place after the owner’s death, which can create a financial strain on the business. Also, payments to the deceased owner’s estate depend solely on the success of the business.
- Cash isn’t always king: The purchasing partner could use cash to purchase the business. This can take many years and isn’t always the best use of cash reserves and not always available if the purchase of the business needs to happen quickly.
It’s important that you as an owner, along with your partners, understand how these funding solutions could impact your business, your income, your taxes, and your family. It can be a significant burden utilizing cash flow to make installment payments, seek a business loan, or coming up with the cash for a buyout of a partner.
Five Reasons Business Owners Should Have a Buy-Sell in Place
- Control the disposition of business: It’s important for an owner to have the peace of mind they have put the right tools in place to ensure the success of their business after they are gone.
- Guarantee a buyer: When planned in advance the owner knows with certainty the buyer is in place and there won’t be questions about getting the funding secured.
- Predetermined Price: Having a predetermined price eliminates the stress of negotiations that occur when an owner passes away with no succession planning, otherwise it will be based on fair market value.
- Tax relief: If the death benefit is equal to the market value of the decedent’s portion of the business, there is no taxable gain for federal income tax purposes for the business. And, if certain requirements are met, the predetermined price in the buy-sell agreement will fix the value of the business for federal estate tax. You should always seek the advice of a tax advisor to confirm tax implications for any business or estate planning.
- Fairly treat non-business family members: Having the details hammered out ahead of time ensures the family is taken care of and not put in a compromising position.
Using life insurance to address business succession planning can also help with employee retention, providing certainty to employees during a stressful time.
Buy-Sell Considerations For Business Owners
In order to really understand the buy-sell discussion, ask yourself the following questions.
- What would you do if you lost a key partner?
- Do you want to go into business with your partner’s spouse or family?
- Do you have sufficient cash reserves to buy out the deceased owner’s share?
- How would it feel to use revenue to buyout a deceased owner’s family?
- Does your retirement plan reflect the sale of your business?
- If you died today, what would the consequences be to your business, business partners, subsidiaries, employees, customers, debtors, creditors?
- If you were to unexpectedly pass away, would your family understand the transition of your business, and they were treated fairly?
These concerns can be solved by using life insurance to fund your buy-sell agreement.
Without a business continuation strategy in place, survivors, including family members, remaining owners, and employees, may be left with many issues and problems to deal with after the business owner’s death. Some of these issues include the following:
- Surviving business owners may want to reinvest profits while the deceased owner’s estate wants annuity payments.
- Stock-redemption needs to be clearly laid out.
- Creditors may question the company’s business interest and ability to maintain the level of profitability necessary to service loan obligations.
- There may be no established market for the business and the estate may not be able to secure a fair market price for the business.
- The surviving family is losing income.
- Owners are forced to finance the buyout over a term of years with after-tax dollars during a time in which the company has experienced a substantial financial loss of a key person.
- Obtaining a loan after the death of a key partner may be difficult until the business has proven its ability to sustain and grow.
Two Common Ways to Structure Buy-Sell Agreements
There are many ways to structure buy-sell agreements, here are two of the most common ways these agreements are structured:
Cross-Purchase Agreement (Personally Owned)
Cross-purchase agreements are agreements between each business owner and address each owner’s interest in the business. For example, if you are working with three business owners with equal ownership, each business owner would own life insurance policies on the other two partners. Then they would name those partners’ families as beneficiaries on the respective policies. If a triggering event occurs this would provide immediate funds to buyout the ownership interest of the deceased partner. Each Owner/Partner would need to Own and pay for the policies they buy on their respective partners.
Below is an easy way to figure out how many life insurance policies you need to write in order to fund a cross-purchase agreement. As you can see from the example above, there are six life insurance policies needed for this cross-purchase plan scenario.
N (Number of Partners) x (N-1)
3 * (3-1) = 6
Cross-purchase agreements can provide some benefit in the planning process but are often not implemented because of the number of life insurance applications needed per each owner and the maintenance of these policies once they are in place. This type of planning can also be challenging where there is a big age difference among owners.
Entity Purchase Buy-Sell (Business Owned)
Entity purchase is the most common and cost-effective way business owners fund buy-sell agreements. This is because it is simple and easy to understand, and less maintenance for each individual owner. This type of agreement also removes the difficulty of explaining the price differences due to the age or health of each partner since the business will pay for all policies (vs. each owner paying as stated in the Cross-purchase agreement).
In an entity purchase agreement, the business is the owner and beneficiary of the life insurance policy in order to buy out ownership from the deceased owner’s estate. This makes it possible to have only 1 life insurance policy for each owner.
What to Know before completing our Buy-Sell Process
We have made a simple, easy-to-use process to help you in establishing an Entity Purchase buy-sell agreement. In our process, we will provide you with a business valuation (or you can use a professional valuation that has been provided to you), a clear structure of death benefit for eash owners’ percentage of ownership, and a PDF summary for you to share with your partners and keep on file. Below are some key pieces of information you should have prepared and you can get through our process in only a couple of minutes!
- Type of Business: What type of business entity? Sole proprietor, LLC, Partnership, S corporation, C Corporation, etc.
- Ownership interest: Who owns the business? How many owners and what are their respecting ownership interests?
- EBIDTA: Earnings refer to earnings before interest, tax, depreciation, and amortization (aka EBITDA). EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.
- Long-term Growth Rate: This rate is the growth rate for the business, expressed as a percentage, used to project growth on a long-term horizon. This rate should be more conservative than the projected growth of the earnings rate used.
- Assets: Business assets are adjusted to reflect fair market value, or the liquidation value of the business, as opposed to the depreciated value for income purposes.
- Liabilities: Liabilities of the business, typically debt or other debt instruments.
With this information, we can help you structure the funding plan for your buy-sell agreement as well as have each owner apply for life insurance in minutes! No need to schedule a call to talk with an agent, we will walk you through the entire process.
Buy sell agreement is a critical element of a business succession plan and it’s most commonly funded using a life insurance policy.
Business owners use life insurance for various strategies in their business such as buy sell and key-person funding, attraction & retention programs, and more.
There are key pieces of information needed to get a buy-sell agreement funded and with a little upfront planning, the process can go very smoothly.
Which Type of Insurance is right for you?
Everyone has their own needs, wants, and wishes for buying life insurance. Ultimately the best life insurance policy is the one that pays out to your beneficiaries when you need it to. Working with a Quote-Bot will help you find a budget-conscious life insurance plan to make sure your family members or business partners are properly taken care of when you need them to be. Here are two of our most popular term life insurance products.
Fast Quoting Process
Our quoting process takes about a minute to complete and view your quote. We also instantly update your quote with any changes you would like to see, without having to start all over!
Instant Decision Underwriting
For many, you can go from our quote to a completed purchase in less than 10 minutes! Our Instant Decision process keeps you from having to wait around to see if you qualify.
Solutions That Fit Your Needs
We pride ourselves in providing high-quality and well-planned solutions no matter how big or small your need is. Our solutions will bring you from concept to completed purchase in minutes!
Frequently Asked Questions
Our process and solutions are designed to help remove the need to talk with an agent. But yes, you can speak with an agent if you like. You can use the chat feature on this page or call and speak with an agent.
Missing a premium is an important thing to know about and thankfully there are programs in place to help notify you if you do miss a payment. Typically you have around a 30-day grace period to make your payment. The insurance company will email you but may send you paper mail, making you aware of the payment issue and giving you instructions on how to resolve it. If you do not make a payment during the Grace Period, you will have to go through underwriting again to keep your coverage.
If you are age 18-50 and applying for up to $1,000,000 of Death Benefit, or ages 51-65 applying for up to $500,000 of Death Benefit, you may not need an exam! When you apply outside of those death benefits or ages, you are required to have a medical exam. Don’t worry, well will help arrange that for you. These exams are required (if needed) so the insurance company can verify your eligibility and your premium amount.
Instant decision means that we will let you know immediately (possibly up to 90 seconds) whether or not you are approved, if we need more information, if you were declined or if you need an exam. No need to wait around very long for answers.
Our Instant Decision process takes 10 minutes for most to complete. Some are faster, some are slower. The good news is that once your done with your application, we give you answers anywhere from instantly or up to a 90 second wait or so. It’s Fast!
No. We strive to provide a solution that allows you to go from beginning to end in minutes without the need for speaking to an agent.