Funding the Buy-Sell Agreement

One of the key components of business continuity planning is the buy-sell agreement.   The buy-sell agreement is an agreement among the owners designed to establish a predetermined and agreed-upon business value (or method of arriving at the value) at the occurrence of certain trigger events such as the death, disability, divorce, deadlock, voluntary or involuntary termination of an owner, retirement of an owner or the attempted sale to a third-party.  Unfortunately, just how the interest is going to be paid for upon the occurrence of one of the triggering events is often over-looked.  Failure to consider how this will happen can be devastating to both the company and the selling owner (or her family).  Here are a few options to consider:

  1. Cash Fund – Keeping enough after-tax cash available to pay they purchase price. The problem is knowing in advance if you have enough time to build up the cash fund. We never know when the triggering event is going to happen. It is also difficult to tie-up that much cash at any time.

  1. Borrowing – Borrowing from a bank is pretty straight forward, but there is no real certainty as to whether a loan can be obtained at the time it is needed.

  1. Installment Payments – Installment payments can be a good alternative, but careful thought should be given to the term and interest rate. A longer term and lower interest rate is good for the business, but may be a hardship for the departing owner (or her family).

  1. Insurance – Insurance can present an excellent option to meet the needs of both the seller and the buyer. The downside of course is the immediate premium payout, but the ready source of funds is a big plus. Insurance is not available for all triggering events, but at a minimum it should be in place to fund in the event of a death or disability.

Often overlooked or not properly funded, the buy-sell agreement is a vital part of the planning for any closely held business.  The options are many and the ramifications of the choices are significant.  If you do not have a buy-sell agreement in place, commit to getting it done and done properly.  If you have a buy-sell agreement currently, regular review is important to make sure it is up to date and will work the way everyone expects.