Insurance-Funded Buy-Sell
Agreements May Be Best
A buy-sell agreement may be legally binding, but unless it is funded there is no guarantee that promises made will be kept. Thus, a buy-sell agreement is only as good as the financial arrangements supporting it.
Advantages: The best way to fund a buy-sell agreement may be with life or disability insurance. Here's why...
- Depending on age and health, insurance is usually purchased with discounted dollars.
- Life insurance makes the exact amount of money needed available at exactly the right time, tax-free.
- Disability income buyout insurance, which usually may be purchased in addition to any individual disability coverage the principals may have, enables businessowners effectively to fund their disability buy-sell agreements.
- The owner's business interest is converted into liquid dollars.
- The remaining principals receive the business free and clear, purchased with funds that are not needed to operate the business.
- Cash values of permanent life insurance used to fund stock redemption buy-sell agreements appear as assets on a company's balance sheet.
- Banks and other lenders view a funded buy-sell agreement favorably when reviewing loan applications.
Other funding methods: A number of other funding options are available, but none is guaranteed, and all raise serious questions...
- Operating capital. Will there be enough cash on hand when the time comes? Even if there is, what effect will this have on cash flow and operations?
- Business loan. Nothing clears out faster than business stability when the owner dies or is disabled. Can even sympathetic lenders be counted on to loan money to a business which has just lost one of its principals? Loans must be repaid with interest.
- Installment payments. Will the company always be able to meet these obligations? What happens if the company goes out of business? Also, interest on installment payment increases the purchase price.
- Create a sinking fund. Will there be enough time to build a large enough fund? Does the business wish to incur potential accumulated earnings tax penalties?
In short, if business continuation is a serious concern, the only real questions are which type of buy-sell agreement should be used, and how much insurance will be needed.
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