Before establishing a burgeoning business, you must lay a strong foundation. Succession planning is one of them, which every business needs to have. No one can anticipate situations like the death or disability of an owner, but you can prepare to deal with it.
Planning for business succession paves the way for the efficient transitioning of business management and ownership. A Buy-Sell agreement is one of the components of this arrangement. It can allow you to keep your business up until any unspecified event, such as disability, death, or retirement, occurs. Nevertheless, there are different considerations of this arrangement, for which you need to keep reading.
Defining Buy-Sell Agreement
The term “buy-sell agreement” refers to a legal contract that specifies the reallocation of a partner’s share after their demise or leaving the business.
Moreover, these arrangements include selling the available shares to the prevailing partners or the business partnership. Generally, business partners employ it, but you can also use it if you are a limited liability corporation or a sole proprietor.
Apart from a buy-sell agreement, this arrangement is known as a business prenup, a business will, or a buoyant agreement.
Related: What is a Buy-Sell Agreement？
The Key Elements to consider for a Buy-Sell Agreement.
Buy-sell agreements comprise many sections and plans, which simplify dealing with certain situations a business can face. Once prepared to begin with it, here are the elements for you to consider:
- Determining the parties
- Inducing buoyant event
- Buy-sell arrangement
- Valuing company
- Financing the resources
- Taxation consideration
Funding for a Buy-Sell Agreement
Undoubtedly, a buy-sell agreement is essential in a succession planning strategy. However, it nowhere eliminates the fact that you always need to be aware of making financial arrangements for the same. Some owners plan to save money or look to take out a loan for it.
However, these are not the only ways you can always set apart the funding from the life insurance of the deceased owner’s interest, with funds reaching the family.
Before you finalize your funding method, it is necessary to find the ideal one.
Let us look at the advantages and disadvantages of utilizing life insurance and bank loans for buy-sell agreements.
Funding Buy-Sell Agreements with Life Insurance
When life insurance is used with buy-sell agreements, the individual co-owners of the business purchase the life insurance policies for every owner, but not for themselves, if one were to die, the policy owner would obtain the death benefits from the policy on their life.
The deceased’s family will get the money for their interest in the organization. If everything works perfectly, the relations of the departed partner will get the money to aid their living. On the other side, the company will secure its continuity.
Advantages of Life Insurance Policy
Utilizing a life insurance policy for a buy-sell agreement comes with several benefits. Firstly, it creates extensive cash to support the buy-sell agreement. Secondly, its proceeds are settled after one’s death. Life insurance proceeds are exempted from income tax. However, a C-corp can have the possibility of paying for AMT. If enough cash has been created with the policies, you can use it to fund after retirement or disability.
Disadvantages of Life Insurance Policy
Well, there is always a flip side to the coin! The use of life insurance to fund a buy-sell agreement can have its benefits, but there are several disadvantages too. Even though the proceedings are tax-free, the premiums are not. Regular premium requirements can be a recurring expense. Also, there can be the possibility of a partner having a disease, making them uninsurable.
There can also be a wide range of variations in the age of the owners, which means the younger co-owners will have to pay a higher premium. At the same time, if there is a difference in the ownership percentage, it will call for more insurance. It would eventually lead to higher premium costs for the ones with smaller ownership interests.
Funding Buy-Sell Agreements with Loans
Apart from the life insurance, you can also consider taking a bank loan to fund the buy-sell agreement. It can allow you to operate the business in the most-efficient manner before any triggering event occurs. It can save your firm from paying monthly premiums or putting aside some money from its revenue.
Disadvantages of a Bank Loan
Nevertheless, just like life insurance has disadvantages, a bank loan can be troublesome in many ways. That is because a bank may need to show more confidence to offer financial support to an organization that has recently lost one of its owners.
You can resolve this issue by keeping up a sufficient credit line that covers the parts or entire purchase before the triggering event occurs. Another issue with a bank loan is that it would need periodic payments. This will stress the cash flow at a time when the business would have turned weak after losing its owner.
A buy-sell agreement is necessary for a business’s succession planning. It specifies the arrangements in a challenging situation and promises the benefit of a strong infrastructure for a business organization. It ensures business continuity, safeguards the company’s ownership, and reduces the possibility of disputes. The list can also relieve stress and shield the business, its owners, and its assets.
Funding is just one aspect you have become aware of, and you can have other queries related to the same. At Lions Financial, we are aware of your scenario. That is why we offer our comprehensive services for buy-sell arrangements. Whether you need professional assistance or are looking forward to seeking financial solutions, we are here for you.
Moreover, preparing a buy-sell agreement requires a comprehensive review of available funding options. The owner may eventually have to decide between purchasing life insurance or getting a loan to purchase a business partner. This is one of the considerations you should always consider as a business owner. You must know what to do in such a circumstance. To build a plan for the future development of your firm, it is recommended that you seek professional assistance.