The Ultimate Assurance of Buy-sell Agreements
The next time you take a breather from the crises of the day, consider this question: What would happen to your company if you died or became disabled? Many business owners do nothing to plan for such events; they assume their families could sell their companies. They see death and disability as remote threats, and they spend their time worrying instead about everyday problems such as sales, inventory, and payroll.
Doing nothing, however, endangers all who depend on your success—your family, your partners or key employees, even your suppliers and customers. Death or disability can destroy a business, leaving nothing behind for those who sacrificed for it. There is, however, a solution to the problem—a legal document called a buy-sell agreement. Tailored to fit your circumstances and properly funded by life and disability insurance, a buy-sell agreement guarantees that your death or disability will not strip others of everything you have accomplished.
Policies And Players
How does a buy-sell work? In brief, it gives your family a guaranteed buyer for your business in case you die or become disabled, and the purchase price is agreed upon before, not after, disaster strikes. Moreover, a buy-sell agreement gives the buyer the money to carry out the deal. More specifically, if you have partners or minority stockholders, a buy-sell commits them to take control of your company, and the insurance enables them to do so. Similarly, a buy-sell could allow your management team or key employees to buy out your interest.
The benefit to your family is clear: Such an agreement gets a cash buyer for your company with no muss or fuss. For your partners or key employees, the benefit is equally clear: They get a going concern free of encumbrances to outside parties who probably have no firsthand experience running your company.
Buy-sell agreements can become dizzyingly complex, however, and that's one reason why many business owners don't put them together. And they can be costly to set up and fund. Drafting the agreement requires legal and possibly accounting help as well as good advice on the insurance that makes the agreement effective.
The key player in creating a buy-sell agreement is usually a life-insurance agent. You want one with broad experience in dealing with the problems of business succession planning, preferably one holding a designation such as CLU, ChFC, or CFP (respectively, chartered life underwriter, chartered financial consultant consultant, and certified financial planner).
What kind of insurance do you need? Many business owners buy only term life insurance because it delivers the biggest death benefit for the least amount of money. If you want the life insurance in your buy-sell only to fund the agreement itself, term is a good option. Cash-value insurance costs more—and does more. The cash builds over time and could supplement your pension benefits or help you buy out a partner who retires or quits. Cash-value life insurance also looks good when you negotiate a bank loan or other financing for your business.
Like cash-value life insurance, disability coverage can be costly. And it may not be easy to get, depending on your age, health, and occupation. Nonetheless, insurance professionals maintain that the buy-sell agreement funded only by life insurance covers only part of the risk and that disability insurance is at least as important as life insurance in such an arrangement. The National Association of Insurance Commissioners calculates that at age 45 a man faces an 18 percent chance of becoming disabled for 90 days or more before age 65. A woman at age 45 stands a 24 percent chance.
A Preservation Plan
In short, a buy-sell agreement can bring peace of mind to all concerned—as business partners Ray G. Ellis, Scott Hopkins, and John L. Leimbach discovered when they negotiated their buy-sell several years ago. The three partners own Mailing Concepts, Inc., a direct-marketing agency in San Diego. The agency, founded by Ellis 11 years ago, serves customers such as BankAmerica Corp., the Smithsonian Institution, and 3Com Corp. Hopkins and Leimbach are vice presidents with minority stock interests. "It took us about six months to put the [buy-sell] package together," says John Leimbach, the company's chief financial officer.
"But when we got it done, we knew we had guaranteed the long-term survival of the company in the event of the death or disability of any one of us." Through a referral, Leimbach met Jim Whistler, CLU, ChFC, an agent in San Diego for Milwaukee-based Northwestern Mutual Life Insurance Co. In a series of meetings, Whistler explored the partners' plans and problems. With help from their lawyers and accountants, he shaped a buy-sell agreement funded by life and disability insurance on each partner. The insurance policies, Whistler says, put teeth into the buy-sell agreement by guaranteeing that neither death nor disability could wreck the company the partners built or leave their families in the lurch.
Whistler placed two disability and two life-insurance policies on each partner—12 policies in all. For each partner, one of the two disability policies is payable directly to the partner, guaranteeing him an income in the event of disability. The second policy is payable to the company, giving the other partners the wherewithal to buy the disabled partner's stake. In contrast, both life-insurance policies on each partner are payable to the company. Funds from one would buy out the deceased partner's interest; funds from the other would finance the search for a replacement. One of the life policies on each partner is term insurance, the other is cash-value insurance. A partner who retires can draw on that cash value to supplement his pension.
'Too Busy Running Their Companies'
Clearly, Whistler says, it takes some planning to put together a buy-sell funded by life and disability insurance, and many business owners use the complexities as an excuse to avoid the job altogether. "Most business owners are too busy running their companies to think about these things," Whistler says. "They deal with inventory and sales and payroll, and they don't take the time to think about what would happen if they weren't around. And no one wants to spend money on insurance if they don't perceive the value of it. "But it's better to decide now what to do if disaster strikes because if you wait until it does, it's too late."
In any case, he adds, insurance covering both disability and life is crucial to a good buy-sell agreement. Without the insurance, he says, the surviving partners in a business have no means with which to carry out their commitment to buy the interest of the missing partner. Leimbach agrees. "I looked at these policies and I said, 'Gosh, these things are expensive.' But you buy insurance for things you hope don't happen. These policies make it easier to sleep at night."
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