What's the Best Way to Fund a Buy/Sell Agreement for Your Business?

Best Way to Fund a Buy/Sell Agreement for Your Business

Many small business owners have entered into their chosen profession looking to make a real impact on the world. The majority of us who are in business for ourselves got here thinking that we have something to offer society. 

Many times we go it alone, and many times we take on one or more partners. We often times have different provisions to protect ourselves in the event of disagreements, or financial hardships such as articles of incorporation or a shareholders' agreement.

There is one major problem that many business owners may not even have thought about, let alone addressed. What happens if one business owner can no longer contribute to the company in the event that one of life's unthinkable moments comes along and removes them from the equation of the business such as premature death or disability? What happens to their shares, and what happens to the remaining partner?

This is where another important business document comes into to play known as the buy/sell agreement. The agreement generally states that if one partner passes away that the other surviving partner will buy out their shares (usually from their spouse). This does two things: 1. It ensures that the family of the deceased gets the current equity available in their business, and 2. It ensures that the surviving partner does not inherent a reluctant partner.

There are three important pieces to any good buy/sell agreement that need to be crafted in order to ensure that all parties are benefited.

1. The shares of each partner need to be valuated. This is usually down by an accountant, and may have a provision for future valuations in the event that the share increase in value.

2. A lawyer who actually draws up the agreement.

3. A source of funding for the each partners shares in the event that something happens.

A good financial advisor will usually act like a quarterback in these situations directing all parties to come to a quick and easy resolution to the problem at hand.

Number 3 is where the problem generally lies. Most business owners have the majority of their capital tied up in their businesses and do not have the immediate cash available to buy out their partner's family which can be a large issue especially in the survivors need cash to pay off the deceased's debts and live. Most lawyers will word the agreements to state that one partner will buy the other out over time, but this is not favorable for everyone involved.

So, how do we create immediate tax free cash?
Life insurance is the absolute best way to fund a buy/sell agreement. If two partners own a business equally that is worth $1 million then they should each own a $500,000 policy on the other if the shares are split 50/50 of course. Immediate cash is created, tax free, while bypassing probate for the beneficiary. The survivor's family gets paid, and the surviving owner is free to pursue the original direction of the business.

This is the most affordable way to take care of the cash shortage. And, the premiums may be tax deductible to the business if the policies are corporate owned.
Who knew that funding a buy/sell agreement could be that easy?

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