Is your business prepared for the death, disability or critical illness of one of its owners or partners?
Should your business lose an owner/partner to any one of these 3 situations, the remaining owners/partners must decide how the business will continue. Generally, you have four options:
- You can close down the business, but you likely wouldn’t want to do that after all of the time, energy, commitment and money you have put into it.
- You can continue the business with the new owner who has acquired their shares via roll-over (for example, could be the spouse of a deceased owner), but do you want to be in business with this person?
- You can sell your shares, but who will buy them and at what price? Will the other owners/partners approve of the person who is purchasing your shares?
- You could purchase the shares from the deceased owner’s estate, the disabled partner’s spouse or the critically ill owner/partner.
A key component of an integrated financial plan for the succession of a business would be the inclusion of a formal Buy/Sell Agreement. These agreements cover the terms of ownership and operation of the business. It usually deals with the death, disability critical illness and retirement of one of the owners, as well as disagreements that could arise about running the business resulting in an owner wanting out of the business.
The Buy/Sell Agreement should include a formula or process for valuing the business to simplify the buy-out of an owner/partner in the event of death, disability or critical illness and will generally deal with:
- Who will buy the shares.
- What the terms of the sale will be.
- When the sale will take place.
- What the purchase price of the shares will be.
- Where the money to buy the shares will come from.
Proper funding must be in place to ensure that your agreement is viable. After all, without funding in place, agreements can fall apart because the remaining owners, obligated under the terms of the agreement to purchase the departing owner’s/partner’s shares, may not be in a financial position to do so. The options available for funding would be:
- You and your partners can start saving today but will you have saved enough if the event occurs within the near future?
- You can borrow the funds from the bank when you require them, or can you?
- You can take funds from current or retained earnings, but what if earnings are down and retained earnings are negligible?
- You can sell assets, but unfortunately, assets usually sell at “fire sale” prices when a business has suffered a loss.
You can purchase Life Insurance, Disability Insurance and Critical Illness Insurance to provide the funds needed at the time they are needed! Often, the best and least expensive alternative for buy/sell funding is insurance!
There are several advantages to having your Buy/Sell Agreement funded with Insurance Policies, some of which are listed below:
- Heirs obtain a definitive value for the deceased, disabled or sick partner’s interest in the business.
- Surviving owners/partners obtain total and unrestricted ownership of their business.
- Depending upon how the insurance contracts have been structured, insurance proceeds can flow into the business 100% Tax Free!
- Depending upon the nature of the applicable insurance contract (life, disability or critical illness) the proceeds can be realized within a very short and crucial time period.
- Depending upon the type of insurance policy purchased, the longer the policy is in force, the greater the cash surrender value, which can be used to take advantage of other business opportunities.
It is important to note that there are numerous possible ways to structure both the Buy/Sell Agreement and the Insurance contracts funding them. Each method has its own pros and cons, particularly when it comes to taxation, so it is imperative that all circumstances be examined by your Legal Council and Accountants in order to secure the Agreement that fits your own unique situation.
Health Risk always recommends that your Accountant play a role in the establishment of appropriate insurance programs in order to determine the proper tax implications for your Company or Business. We also recommend that your Lawyer be involved in the establishment of any legal documents necessary to the implementation of insurance program funding.
Health Risk is prepared to work with your company to assist in the process of ascertaining the appropriate Buy/Sell Agreement, or if in fact you already have one in place, to identify the insurance product solutions necessary to fund your agreement. We will endeavor to work closely with your professional team of Accountants and Lawyers to ensure that every detail is covered.
DISCLAIMER: Please be advised that the information on this web site is intended to present a broad variety of general information as simply and accurately for your knowledge as we possibly can. In no event does this information form part of or apply as a legal document. Therefore, please note that rules, conditions and industry practices discussed may be changed over time.