Creating a buy-sell agreement locks in your exit strategy and provides certainty. It ensures your company can continue smoothly, no matter what happens. Planning for your business’s future after you or your business partner leave is crucial. It could make or break the transition, determining whether it succeeds or leads to financial trouble.

 

How to Handle Ownership and Control When a Business Partner Exits

If you’re in a partnership business, think about what would occur if something happened to your business partners or you. What if one of you wants to leave, becomes disabled, retires, or sadly passes away unexpectedly?

Suppose you’re the only business owner now but plan to sell it later. In that case, you must consider how your company depends on your skills and reputation. Would it be wise to transition ownership smoothly rather than changing hands suddenly? Alternatively, hiring a skilled person could be a good transition plan. You could gradually transfer ownership over a few years, allowing your clients to get to know the new ownership.

 

What If You Lack an Exit Strategy?

When you are in a partnership business, your family’s well-being is directly impacted by how well the business does. How can you safeguard the well-being of your family, regardless of what happens to you or your business partner?

Contingency planning often gets ignored because it’s not seen as an urgent matter.

Planning how you sell or transition can determine whether you’ll have peace of mind or face turmoil. If your business smoothly continues even after losing an owner, you and your family will keep enjoying the financial benefits of your hard work.

If the company faces difficulties and struggles, it might result in unhappy clients, the inability to meet contracts, and a decline in revenue. This could lead to financial problems for you and your family.

It’s essential to consider and plan for different possibilities to fully enjoy the rewards of your hard work, regardless of when or how you or your business partners leave.

How to Plan Your Exit Strategy

Why is planning an exit strategy important?

Planning your business exit enables a smooth transfer of ownership when a partner decides to leave the company.

What factors should I think about when establishing a buy-sell agreement?

A buy-sell agreement should address every possible scenario for you or your business partner leaving the business. This includes mental or physical incapacity, disability, divorce, retirement, or death.

Why is financing a buy-sell agreement so crucial?

You can only use a buy-sell agreement funded to carry out ownership transfer plans.

How can a buy-sell agreement be funded?

You can pay for your buy-sell agreement in different ways: using cash, getting disability and life insurance, paying in installments, borrowing, or setting aside money regularly. Insurance is the best option because it’s the cheapest and most reliable way to get money.

How does life insurance solve buy-sell funding challenges?

Life insurance serves three critical purposes in buy-sell agreements:

1) The business can hold policies on its owners.

2) Owners can individually buy policies on each other through a Cross-Purchase agreement.

3) An LLC buy-sell agreement involves creating a new entity to own policies on the owners.

In the event of an owner’s death, the policy payout is used to purchase that owner’s share of the business.

 

The Place of a Buy-Sell Agreement in the Cash Flow System

 

Funding buy-sell agreements are part of the more extensive journey toward achieving time and financial freedom.

To achieve financial freedom, you need to go through three fundamental steps. The first step involves saving more money by sealing any financial leaks. Next, you’ll safeguard your money through insurance, legal measures, and Privatized Banking. Finally, you’ll invest your money wisely, boosting your earnings with assets that generate cash flow.

A Buyout agreement is a crucial aspect of Stage 2. It safeguards your stake by providing the resources you need to buy out a co-owner and retain control when they leave.

Using a Specially Designed Whole Life Policy, your Buy-Sell Agreement can become a tool for Infinite Banking.

 

Why is it Important to Plan an Exit?

Options

Planning ahead offers you a significant advantage since you have options. But if you wait until the last minute, you limit your response chances.

Peace of Mind and Predictability

The same principle applies to organizing plans for business continuation in case of unexpected events. You feel more at ease when you plan how to maintain continuity and stability, even in challenging situations.

If you face obstacles, employees, customers, suppliers, and creditors will know what to expect. They can rely on daily operations continuing smoothly. Your family’s financial security is guaranteed when your future is more certain.

Fair Bargaining

Planning for the smooth transfer of company assets ensures that all owners have an equal say in the discussion without worrying about fair treatment.

For example, if one co-owner dies suddenly, their family might urgently need money. This could make them less powerful in negotiating a fair price for their share. They might have to sell for less money. They might even sell to an outsider to force the company to close, or they could sue the other owners if they feel unfairly treated. Then, the remaining owners might end up doing business with someone they don’t know who doesn’t have the same goals. Even worse, they might be unable to make crucial decisions.

 

What Situations Should I Think About?

There will be a moment when you leave your business, either by choice or by force. This situation might lead to a sudden need to transfer ownership to ensure everyone is treated fairly. You should think about and prepare for three main situations: death, disability, or retirement. Additionally, consider factors like mental incapacity and divorce.

If an owner wishes to retire, they have a few options. They could still earn income as an owner while working fewer hours. Alternatively, they might prefer to sell their company share and leave entirely. In this case, they’ll want a fair price for the years they’ve put into the business.

What happens if a disability stops an owner from carrying out their duties, affecting the company? The disabled owner will require income and might choose to sell their stake in return.

Just like spouses who rely on each other get life insurance, families in business also insure themselves. If one person dies, the other is financially secure. You work together as a team in your business, and your income depends on everyone staying alive. If someone passes away, your livelihood could suffer. Their spouse probably won’t want to take over, and you might not want to do business with their ex.

What if you couldn’t lead anymore because you lost your mental capacity and can no longer offer vision? Or, what if your business partner got divorced? Then, their ex could demand half of what they own in the business.

 

What Are Buy-Sell Agreement?

Simply put, it’s a legal agreement stating what will occur when an owner leaves. It arranges to sell the business share if someone retires, dies, or becomes disabled. This agreement sets the business’s worth and the ownership percentage for each owner.

For instance, let’s say Richard and Kevin co-own a $2 million company, each having half of it. Their buyout agreement states that if one of them passes away, retires, or becomes disabled, the other person will take over all the ownership. So, if one dies, the other will have complete control of the company.

Hire a skilled lawyer to write this contract to ensure you handle all possibilities.

But even if a buy-sell agreement is well-written, it’s useless without funding. That’s why it needs the money to carry out the sale and change ownership.

 

Is a Buy-Sell Agreement Necessary?

In the example we discussed earlier, if Richard were to pass away, Kevin would require $1 million in financing to purchase Tom’s share of the company.

Kevin’s estate would still own half of the company if there weren’t enough funds. This implies that Richard’s heirs, be they children, spouses, or others, would then possess half of Kevin’s company.

In such a situation, Richard’s heirs might lack the skills or interest to manage a company. Alternatively, Kevin might strongly dislike the idea of partnering with Richard’s widow.

Richard’s heirs would most likely benefit more from selling their half and having $1 million in cash instead.

The best scenario would be for Kevin to have enough cash to buy out Richard’s ownership share. This would result in Kevin owning the entire $2 million company, while Richard’s estate would receive $1 million in cash.

 

How Can Buy-Sell Agreements be Funded?

Numerous funding options are available for buy-sell agreements, with varying degrees of success.

Cash

You might consider using cash to fund buying and selling. However, this requires having enough money, which many businesses don’t have readily available. Many businesses often invest their capital in inventory and assets. If you rely on cash, you may need to sell off inventory or find yourself with insufficient cash.

Sinking Fund

Another way to fund is through a sinking fund, where you gradually set aside reserves. However, because you can’t foresee the timing of unexpected events like disability or premature death, a sinking fund might not have had enough time to reach maturity.

A Loan

You might opt for a loan. In this case, the remaining business owners must meet the criteria and secure financing. However, it can be challenging because the event that triggered the buyout might have affected their creditworthiness, and the company’s stability and future might seem uncertain. Also, using a loan adds interest to the overall cost of the buyout.

Paying in Installments

Another way to fund the buyout might involve making installment payments to the heirs, similar to seller financing. Here, the departing owner’s estate receives regular cash flow instead of a single lump sum. However, the company might not be able to guarantee future payments. If the company faces difficulties, these payments could stop.

Life Insurance

Lastly, life insurance policies offer the highest level of guarantees and certainty as a financing choice. A death benefit equivalent to the company’s market value ensures enough funds will be available to carry out the buyout when the triggering event occurs. The full death benefit will be paid out whether you’ve been paying premiums for 15 years or just one month. That’s why it’s the most cost-effective option for funding buy-sell agreements.

Moreover, disability insurance can be another option for purchasing the company in the event of disability.

 

How Does a Life Insurance Policy Address Buy-sell Funding Challenges?

 

You can fund your buyout agreements in several ways, including:

Stock-Redemption

In a stock redemption buy-sell arrangement, the company invests in insurance policies for its owners. When one of the owners passes away, the company receives the death benefit from the policy. Subsequently, the company uses this payout to buy out the departing owner’s share from their estate. As a result, the company acquires the stock while the estate receives a cash settlement. This transaction ensures that the remaining business owners retain full ownership of the company.

Here are the advantages and disadvantages. You would require only one policy per co-owner, simplifying the process. However, the surviving co-owners wouldn’t benefit from a step-up in basis. This implies that they might have to pay capital gains tax on the portion of the business they inherited from their partner if they decide to sell it later.

Cross-Purchase

Another method to establish a buy-sell agreement using insurance is through a cross-purchase arrangement. In this setup, each co-owner buys insurance policies on the others. For instance, Richard and Kevin purchase policies on each other. If Richard passes away, his policy pays out to Kevin, who is both the owner and beneficiary of the policy. Kevin utilizes the funds to purchase Richard’s shares. Once more, this ensures that both parties are fully compensated.

In the cross-purchase buy-sell agreement, the individual receiving the company shares can benefit from a step-up basis. However, the drawback of this arrangement is that it can become cumbersome. Since each co-owner purchases insurance on every other co-owner, multiple policies are required for each person if there are three or more co-owners.

Stock-Redemption

In a stock redemption buy-sell arrangement, the company invests in insurance policies for its owners. When one of the owners passes away, the company receives the death benefit from the policy. Subsequently, the company uses this payout to buy out the departing owner’s share from their estate. As a result, the company acquires the stock while the estate receives a cash settlement. This transaction ensures that the remaining business owners retain full ownership of the company.

Here are the advantages and disadvantages. You would require only one policy per co-owner, simplifying the process. However, the surviving co-owners wouldn’t benefit from a step-up in basis. This implies that they might have to pay capital gains tax on the portion of the business they inherited from their partner if they decide to sell it later.

LLC Buy-Sell

The LLC buy-sell presents a third option, especially beneficial when there are three or more owners, as it streamlines the transfer process. In this scenario, a new LLC would acquire a policy on each owner, reflecting the same ownership interests as the original business entity.

In this setup, every individual receives a step-up basis, and only one policy is required for each owner. Moreover, policies could be transferred between owners without causing a taxable event. However, managing a new entity does involve additional administrative tasks.

 

How to Get Started with Buy-Sell Agreements

Here are some questions to help you begin considering your requirements for buy-sell planning:

1. Does the business have multiple owners?
2. Do you have a plan in place for what occurs if one of the owners becomes disabled or passes away?
3. If another owner were to pass away, do you wish to continue doing business with their heirs?
4. Will your co-owners provide financial support for your family?

5. Will your family be fairly compensated for your portion of the business?

Once you decide you need a buy-sell agreement, the next step is to get a professional valuation of your business. This will determine how much each partner’s share is worth. This value becomes the starting point for figuring out how much money you need to support your buyout agreement.

 

Using Life Insurance to Protect Against Multiple Risks Simultaneously

Insurance serves multiple purposes, so the policies utilized for your buy-sell agreement could also fulfill other objectives. For instance, if you wished to retire or depart voluntarily, the policy ownership could be transferred to you as part of the purchase price. This would allow you to access the cash values through tax-deferred loans and withdrawals.

One or more of your co-owners may be crucial to the company’s operations. You could use the same company-owned policy for key employee insurance and funding your buy-sell agreement. The insurance payout would cover the business’s need to replace the role if necessary. Simultaneously, it would also provide the means to buy back the stock ownership from their estate.

 

Additional Considerations

A buy-sell agreement isn’t something you set up and leave alone. It’s a flexible arrangement that should evolve along with your company. Once you establish your buy-sell agreement, it’s essential to regularly review the funding level. This ensures that funding increases over time to match your company’s growth.

In various situations, insurance could be one component of your funding source, which you may complement with other financing options.

Additionally, although you can utilize term insurance, its payout is restricted to the duration of the policy. For instance, once the ten years of a 10-year term policy elapses, you would need to arrange another insurance policy or establish an alternative funding source.

 

Buy-Sell Agreements and Infinite Banking

Another advantage of a Buyout Agreement is its potential use for Infinite Banking within your business.

With a Specially Designed Whole Life Policy, the policy owner can accumulate capital due to the guaranteed cash value. Depending on the structure of the buy-sell agreement, this could offer either the owners or the company itself access to a significant reserve account.

The distinctive advantage of the Infinite Banking Concept lies in its uninterrupted compounding. Your funds keep growing and compounding within the system, even as you use the capital elsewhere. This is because infinite banking allows you to earn returns in two places simultaneously. As a result, your money stretches further and achieves more.

 

Final Thoughts

We’ve provided an avenue for planning and potential exit strategies that leave you feeling empowered with one less question.

The key takeaway from this discussion is the importance of planning ahead. If you aim to secure the continuity of your business, a buy-sell agreement funded with whole life insurance could be the perfect solution.

Schedule a call with us to initiate the discussion and explore the possibilities. We’ll assist you in navigating your exit strategy and continuity requirements. Plus, you’ll receive guidance on the next step towards accelerating your journey to financial and time freedom.