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1. What does buy-sell funding mean?
Buy-sell funding is a strategy that will create the cash needed to ensure continuity of business ownership and control after a triggering event. The buy-sell agreement, which is essentially a ‘businesses will’, stipulates the legal wording of how the ownership interest and funding occurs. Examples of triggering events are death, disability, retirement, or divorce. Buy-sell funding of the first two triggers is straightforward and can be accomplished with either life insurance or disability insurance. The second two are a little more tricky from a funding perspective as there is no insurance policy that will pay out as retirement and divorce are not insurable risks. Book a call today!
2. What are the differences in life insurance funding options for a buy-sell?
Buy-sell funding is an art and a science. We use all types of insurance strategies to fund buy-sell agreements. We use long term disability to fund disability buy-sell agreements.
Term insurance is a popular option to fund cross-purchase buy-sell agreements where the primary concern is death of another partner. It is definitely the most inexpensive way to fund a buy-sell agreement, but has its own inherent drawbacks. If business valuations rise over the term of the policy, more insurance would need to be purchased to capture the additional value. Term insurance can also expire after the stated term or convert into a renewable policy at unfavorable annually renewing premium rates.
Permanent insurance, such as whole life, universal life insurance (ULs) and indexed universal life insurance (IULs) prove to be great options to fund buy-sell agreements. they are more expensive, but more flexible and can help accomplish multiple goals. Permanent policies are the literal opposite of term policies and are intended to last the life of the insured. If structured properly they can accumulate enough cash to help offset the cash needed to satisfy a buyout trigger from a retiring owner or owner who is being divorced, where the spouse’s inherited interest will need to be purchased.
Using income annuities and indexed annuities is a popular strategy to fund buy-sell agreements where the main trigger is a withdrawing partner/co-owner, as opposed to death being the trigger.
3. How do I know what the business is worth?
A buy-sell agreement establishes a fair value for your ownership shares using either a valuation formula, such as a multiple of earnings or sales, or by setting a value outright. We have tools and resources to help with business valuations, but always recommend initial valuations to be checked by a CPA, CFA, or business appraisal firm. For complex valuation needs, we have strategic alliances with valuation professionals, but those cost are not covered by us.
Having a valuation for your business can help avoid any potential conflicts down the road should a former business partner or their beneficiary demand more for their ownership shares than you believe they’re worth.
Also, in light of growing business valuations over time, the business worth is rising and therefore the funding need rises accordingly. This is where our licensed funding professionals stand out. Utilizing permanent insurance strategies we can help you structure your buy-sell funding in a way that meets your businesses rising valuations.
4. Can a buy-sell agreement be created for any type of business?
We have not come across any business structure for which a buy-sell can not be created. S-Corp, C-Corp, B-Corp, LLC, LLP, LP, Sole Proprietorship…We have worked with our legal partners and have created and implemented funding strategies for each of these business structures.
5. Are your buy-sell services turnkey?
To an extent, yes. There is nothing automated when it comes to buy-sell agreements and funding strategies because every business entity and business owner needs are different. After considering all of the moving parts involved, one strategy may look much different than another, yet still have similar needs and goals.
This is why our initial phone call and needs based questionnaire are very important. East Coast Financial of Central Florida is a full service advisor and insurance agency and we have a network of legal and other professionals we work with in reaching our client’s goals. We can create funding strategies for almost any succession plan need; the aspect that varies is the agreement.
Some of our business clients prefer to use their own attorneys to draft the legal buy-sell agreement. The agreement is the directive and also includes information about business valuations that are normally done by a CFA or CPA. We encourage businesses to use their own attorney’s
Depending on the complexity off the buy-sell agreement, we have a network of virtual attorney’s and programs to create buy-sell agreements for less complex situations: For example, a simple two person partnership with ‘plain vanilla’ needs.
We have a strategic alliance with multiple estate planning attorney’s when clients need an entire buy-sell agreement created and a funding source and strategy implemented. It is important to note that we do our best to keep legal fees as low as possible, but any legal fees are incurred 1 for 1 by our clients. Buy-sell agreements are drafted by our network of multi-state attorney’s at a fixed rate.
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6. Is it true that a co-owner can sell his business ownership to a competitor?
Yes this is true, unless there are restrictions in the articles of incorporation, or the bylaws, subscription agreement, shareholders agreement or another relevant agreement to the specific business. Prior to creating your buy-sell agreement, it is best to write down your concerns and review them with your attorney.
7. My partner and I founded the business together and I expect them to buyout my business interest from my spouse at fair value. So, why do we need an agreement?
It may happen and in a perfect world, business decisions that usually come from a position of logic (and unfortunately many times greed and fear) tend to differ from personal decisions that arise from friendship or the heart. You must remember that in most small to mid size businesses, the value of the business is closely tied to the experience and skill set each owner brings to the table. If your spouse inherits your shares, the value the surviving owners place on those shares owned by your spouse may be much less than the value they would have placed on them if you were alive. This is because of the intrinsic, intangible and experiential value you brought to the table.
This is why it is very important to execute the buy-sell agreement when all owners are healthy. It is fair game If all owners are healthy, attention is not on the spouse and valuations and agreements can be made that are more fair for the spouse that stands to inherit business interest. Also, obtaining life insurance at favorable premiums to serve as the funding source of the buy-sell agreement is much easier when all owners are healthy and younger. We say younger, not young because all other things being equal, every 6 -12 months you wait to create the buy-sell agreement funding source, the more expensive life and disability insurance will be.
8. My partners and I recently formed a business, should we implement a buy-sell agreement immediately?
Maybe…the first thing to consider is business viability. Do you and/or your partners feel this venture is viable? Is this business similar to a business that any of the partners successfully operated in the past? If you and your partners or the co-owners of the business are confident that it is viable, the answer may be yes, if it is too new to know for sure then it comes down to a business decision.
How much capital do you have available? If capital is very scarce and the probability of success of your business venture is lower than you would like it to be, then maybe it is more prudent to use available working capital in a way that focuses on growing the business first.
If you have a good amount of capital available, then it may still be smart to consider. If money concerns are the problem, but you are adamant about getting a buy-sell plan in place, book a call because you don’t know what you don’t know, so we can most likely help.
9. What happens if my business partners outlive the term policy that is the funding source of our buy-sell agreement?
This is a common question and understandably a reasonable concern. For younger companies that have more limited cash available for premium payments, it is not uncommon for the co-owners to use a term strategy. For instance, if there are three 30 year old owners that do a cross-purchase buy-sell agreement and use 20 year term insurance as the funding source, this can be a very economic and effective strategy for ensuring the death trigger of the agreement will be funded.
If a term policies stated term ends, depending on the policy, it will expire or convert into a 1 year renewable term. Rates will be higher as they are based on current age and go up annually. This is why we use A rated carriers with term conversion features only. A term conversion clause allows the owner of the policy (the other co-owner’s in a cross-purchase agreement) to convert some or all of the term insurance to permanent insurance up to the max age or the term of the policy, whatever comes first.
These are valid concerns and this is why you need an experienced team of professionals to make sure you and your business partners make the right decision from the get-go.
We enjoy adapting our strategies to offer every client the best