Let's talk about the top three reasons that you should consider a buy-sell agreement funded with life insurance. What is a buy-sell agreement exactly?
Well, here's what it is. When you're in business with business partners, whether one or multiple, you are in a position where your livelihood is contingent upon those business owners continuing in the business.
Each of you is going to exit the company at some point. It's either going to be voluntary or involuntary.
How do you have the business be in a position where the business can continue to thrive and flourish?
What about when one of the business partners does leave.
They could leave due to retirement, or it could be to something like disability or death, divorce in their family, or mental incapacity.
If you're in a position where something happens to your business partner, you want to be in a position where you maintain the full ownership of the business.
How is that going to happen?
You need to have a legal agreement in place where you and your business partners agree upon a value of the business, what your portion of ownership is worth, and what theirs is.
Say it's a million-dollar business and you have a 50/50 ownership. That means your shares or your stock in the business is worth $500,000.
If they pass away, and you want to maintain the business, think about their family for a minute. They're in a position where their livelihood has also been contingent on the company.
So now they have this business, and they want cash instead.
How do you make sure that both parties and their estate are taken care of no matter what?
You need to have an agreement that not only establishes how the transfer of ownership will happen but also secures a funding source to make sure that the remaining parties can buy out the leaving member or their estate.
So the first reason to have a buy-sell agreement funded with life insurance is for the orderly transfer of business ownership if something happens to one of your business partners.
The second reason is that life insurance is the most certain and economical means of providing funding for a buy-sell agreement.
Back to our example where you're in a position where you want to buy out the $500,000 shares from your business partner, and you need to come up with the capital to be able to make that purchase.
The spouse might not want to be in business with you, and you may not want to be in business with them.
Let's figure out how to get the cash to them. I have to be in a position where I can pay that $500,000 to my business partner's estate.
How can we do that? Well, I could have cash reserves so that I could buy them out at any point if the need arose.
But what if I wanted to do something else with the cash?
You could rely on a bank loan, but you're not sure if your creditworthiness might actually be impacted due to the uncertainty of losing the partner.
Another method would be looking at installment payments, where I would say, "Well, the business is gonna pay overtime monthly or annually to my business partner's estate."
But in that case, I don't know about the sustainability of the business, and I really want to make sure I don't put my business in a position of having a financial obligation that I can't meet.
Here's where life insurance fills a need perfectly. It's the most economical and sure way of knowing that if that need should arise, I will have the funds to buy them out.
There are multiple ways of setting up a buy-sell agreement with life insurance, but let's say that my business partner and I had life insurance policies on each other.
If he passes away, I am going to get the death benefit from his policy.
Now, if I set the policies up so that it's a $500,000 death benefit, because that was the value of their ownership, then I automatically know that even if the event happens in six months or in 20 years, if that policy is a permanent policy, I know that whenever that life event occurs, I will have the funds to buy them out, no matter how much I've paid in.
The third reason to have a buy-sell agreement funded with life insurance is simply for the peace of mind.
Life insurance is extremely flexible, is versatile, and it can accommodate multiple life scenarios. What if they leave due to retirement, not due to death? That would be an ideal situation, right? I'm able to transfer ownership of the life insurance policy to my partner and now he can walk away with the cash value that's built up inside of that?
That can be part of the purchase price so that he can retire and get a reasonable and fair price for his contribution to the business. Now certainly life insurance may not even be the only funding source for buy-sell agreement, but it's really critical to think about the long term strategy for what your exit plan is in your business.
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