There are a lot of things to consider as a business owner with a business partner. And one question that should be answered by any successful business owner is what will happen when my business partner dies?
When you go into business with a partner and they die, you’ll have two choices without a properly drafted agreement. Those options are really simple.
- Option one you’re now in a partnership or in business with your former partner’s family.
- Option two, you’ve got to come up with enough cash to equal the equity interest that your partner had.
So the simple solution is to draft a buy-sell agreement, which will detail exactly what you want to have happen when each partner dies. The buy-sell agreement is an obligation that literally tells what has to happen when one of the partners passes away. This brings us to the second part of buy-sell planning, which is funding. Where’s the money going to come from to buy out the partner? Do you have enough cash on hand or are you going to have to liquidate assets in your business? But if you liquidate the assets, how is your business going to function? This brings us to our next option and the best option for funding any buy-sell agreement, which is life insurance purchased on each of the partners that would produce liquidity at the time of death.
The buy-sell life insurance policy is the only option where the problem, the death of the partner, triggers the solution: instant liquidity to buy out their shares. Think of it this way, if you pay cash, you’re giving up that cash amount plus the interest that cash could have earned. You’ll never see the interest you don’t earn on that money. If you pay out over time it’s the same thing. You’re giving up control of the money, plus what that money could have earned. That would be an installment sale. But the third option, life insurance literally gives you a discount. You should never pay more for the business interest than you do for the insurance. The insurance should be discounted from what the principal or the death benefit is.
So the buy-sell agreement creates the obligation. The obligation can be paid either in cash if you have the money, in which case you’re giving up control of the cash, plus what that cash could have earned: opportunity cost. The second way you can buy out your partner is to borrow money from a bank to pay for his business interest. But will you qualify for a loan when you’re down one business partner? Will the business still continue to perform at peak level once that business partner is gone? And the third way is to buy life insurance. Life insurance could literally give you a discount on the amount of money that you need to buy out the partner. Often people look at insurance premiums as a cost, an obligation to dish out money to the insurance company every year. And no one wants to do that. But a simple reframe could shift it into an asset.
First of all, you have full liquidity use and control of any cash value via the policy loan provision that you have access to throughout the policy’s life. And number two, once your partner dies, it triggers an automatic death benefit to fund the problem of the buy-sell agreement. Your obligation to buy out your partner is solved with a snap of a finger. The event that triggers the problem, the death of a partner, is also the event that triggers the solution: life insurance death benefits.
I can’t tell you how many times I’ve seen very successful businesses, businesses that have been around for 40, 50 years that never address the buy-sell issue or they had a buy-sell agreement and it wasn’t funded. I could tell you of a manufacturing company been around for over 50 years – they never addressed the buy-sell issue. When one of the partners died, they didn’t have enough money to buy out the partner, so they had to borrow money. They borrowed money in 2005. Well, when the financial crisis hit, business went down. They didn’t have enough cash flow to pay for the loan and ultimately went bankrupt. That business had been around for over 50 years and went out of business like that because they never addressed the buy-sell issue.
It’s our mission to help as many families and businesses as possible to make the best financial decisions possible. If you’d like to get started with this conversation today, visit our website at Tier1Capital.com to schedule your free strategy session where we could do a deep dive into your situation and how we could meet your needs with a buy-sell life insurance policy.
And remember, it’s not how much money you make, it’s how much money you keep that really matters.