If you are planning on signing a buy-sell agreement for your business, you may wonder about how to fund it properly. There are a few different ways to fund buy-sell agreements, including using personal or business money, borrowing money, making gradual payments, or finding insurance.
Why Does a Buy-Sell Agreement Need to Be Funded?
Giving your interest in the business to someone outright, with no exchange of money, can create massive taxes for your estate (depending on how much the business is worth). You should plan ahead by arranging for some way that money will change hands, even if the purchaser does not contribute the money directly.
Fund It With Cash or a Loan
The purchaser could use his or her own money to buy the interest in the business. This is risky, however, because he or she will not know exactly when the money will be needed. When the business owner passes away or decides to retire, the purchaser may not have the cash available.
Alternatively, the purchaser or the business itself could take out a loan to pay for the former owner’s interest in the business. This carries risks because it is never guaranteed that a bank will approve such a loan, plus repaying the loan could impact the business’s bottom line.
Setting up installment payments solves the issue that the purchaser may not have large sums of cash on hand. With an installment plan, the purchaser can spread out payments over time. The amounts of cash paid each time could be small or large, and the payments can be spaced as needed. The purchaser still has to put up the cash, however. In addition, the business may suffer from decreased credit ratings due to the long-term nature of the payment plan. Also, the business owner’s family might find a lump sum more useful to pay for funeral expenses and fund the estate, rather than small payments over time that the business owner has already spent. And there is a risk that the purchaser will not finish making payments when the business owner dies.
Insurance – specifically, life insurance and disability insurance – is probably the safest way to fund a buy-sell agreement. The payouts from this insurance can cover the cost of the business owner’s share in the company when he or she retires, becomes disabled, or dies. Life and disability insurance rates and availability both depend on the insured’s health, so the business owner should apply for policies as soon as possible.
Planning your estate and need help with business succession issues? Look to Janet Brewer, Esq. for thorough and thoughtful estate planning advice. Janet’s more than 20 years of legal experience will give you confidence and peace of mind. To schedule a “Get Acquainted” meeting, visit Janet's website or call her office at (650) 469-8206.