How a buy-sell agreement can save a closely held business if something happens to an owner.
You hear about pre-nuptial agreements between soon-to-be husbands and wives. But what about people going into business together? It’s actually a really smart idea.
For closely held or family businesses, a properly designed and funded buy-sell agreement can save time, hassle and money, similar to a prenup for some couples. In the end, it could save the business itself too.
- Less than 1/3 of family businesses survive the transition from 1st to 2nd generation ownership.*
- Another 50% don’t survive the transition from 2nd to 3rd generation.*
Why is it so difficult to make a smooth transition? Maybe, it’s because the owners didn’t have a plan in place to continue the business after an owner’s retirement, disability, divorce or death. That is the purpose of a buy-sell agreement.
Benefits of a well-designed buy-sell agreement
Not only will a buy-sell agreement describe the terms under which ownership interest in the business can and will be transferred, but it can also establish:
- A market value for the business, or the way in which the value will be determined in the future. This agreement can eliminate huge hassles (and arguments) later.
- A funding source for the purchase of the ownership interest, and the payment terms for the sale of the business. Without proper funding, the buyer could have to sell assets, take out loans or even file for bankruptcy.
- Restrictions, such as who can own the business or how to transfer or sell ownership interests.
Why fund a buy-sell agreement with life insurance?
You can purchase interest in a business by borrowing from a bank, or making installment payments. However, many people choose to fund a buy-sell agreement with permanent, cash value life insurance because it offers:
- Proceeds Paid Quickly – The death benefit or cash values are available (generally income tax-free) when they are needed, to fund the business sale.
- Cost efficiency – The premiums are significantly lower than the benefit itself, and can be much lower than the expense of a loan, so there’s no large outlay from the business.
- Stability – A life insurance death benefit is guaranteed, so you know it will be available when you need it.