When a business has multiple owners, it's vital that you have a mechanism to transfer ownership in case of an adverse event. Without a plan that all parties have agreed upon, it's much easier for personal and legal disputes to crop up where none are necessary. This is why buy/sell agreements, also known as business prenups, are highly popular. However, agreeing to such an arrangement carries the formidable challenge of choosing between different ways to fund a buy sell agreement.
What is a Buy/Sell Agreement?
In short, a buy/sell agreement is a method by which a business agrees to buy out a partial owner if they leave. If an owner leaves out of their own volition, it's usually possible to come to a suitable agreement through negotiations. For this reason, buy/sell agreements often operate as insurance in case of sudden disability or unexpected death. Buying out a partial owner or their estate after death can be quite expensive, depending on the amount of stock they own. As such, it's necessary to choose between the ways to fund a buy/sell agreement in advance.
Ways to Fund a Buy/Sell Agreement
When it comes to funding a buy/sell agreement, a business will either need to save sufficient capital or find the money when the agreement activates. Any approach will entail its own disadvantages and advantages, and no single choice is absolutely correct. However, there is a case to make life insurance is the ideal funding method in many cases.
Once a business settles its buy/sell agreement, it can start sinking funds from its profits. Eventually, you'll have sufficient capital stored away to fund the agreement. This is a financially conservative, low-risk choice, but leaving so much uninvested capital is unappealing. Furthermore, it's possible for the agreement to come into effect before you've saved enough money.
Take Out a Loan
Taking out a loan is a fine plan B since loans are always available, and it can also be a Plan A as well. The drawbacks to funding a buy/sell agreement through a loan are essentially the same as taking out a loan for anything. Namely, the interest and loan payments will represent an unwanted burden on your cashflow for a considerable amount of time.
Purchase Stock in Installments
Purchasing stock in installments can often be a relatively low-cost, low-complication way to buy the stock of a partial owner. It doesn't entail interest payments in the way that a loan does and economic hardship may reasonably prompt a pause in installments. But then, the problem is that your business won't own the stocks in question for some time.
Long-Term Payment Plan
A long-term payment plan where you receive all of the stocks up-front but pay over the long-term is similar to an installment plan or a bank loan. While you escape the interest payments of a loan, you lose the flexibility of an installment plan.
Taking out life insurance on your business partner doesn't solve a buy sell agreement that activates outside of death. However, it is the ideal solution bar none in the case of death. By paying a small fee each month for the insurance, you'll receive the amount of capital needed to fund the agreement. It has the greatest practical similarity to sinking funds into a savings account, except that there's no risk of reaching the date of the buy/sell agreement without sufficient capital.
Life Insurance with Bridger Financial
Bridger Financial Group is a successful, time-tested wealth management firm. If you're interested in using life insurance to fund a buy sell agreement, get in touch today.