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When first-time business owners enter into a partnership to get an enterprise off the ground, necessities like buy-sell agreements may not always be on their minds. With so many young entrepreneurs populating the startup field, it should come as no surprise that legally binding contracts often take a back seat to marketing budgets and trendy office furnishings when deciding how to spend capital. That’s unfortunate, because a buy-sell agreement is an absolute must for partners who own a joint venture of any kind.
If a co-owner passes away, whether it’s expected or unexpected – or, he or she is forced to leave the business for any reason, whether it’s financial or personal – then a buy-sell agreement is the contract that will dictate the terms of the departure so that the business can continue to operate. Without this agreement, there’s a good chance that the remaining partners will be forced to live with an outcome they don’t want. In the case of an employee death, for example, the owners may be forced to allow the departed partner’s spouse to become the new partner – and while they may like her personally, they don’t necessarily want to be in business with her. Or maybe Johnny Jr., their late partner’s son who has little experience in the business outside of being a stock clerk in the summers, is now their new partner – and understandably, that idea scares them out of their minds. When a buy-sell agreement is established long before anyone leaves the business or passes away, these sticky situations can be avoided.
I use the story of a good friend who has personal experience with this; he was one of four partners in an auto supply business. One day, one of the key partners unexpectedly passed away in the prime of his life and the prime of their business. Because the partners had previously secured a life insurance policy with a “key person” provision, which covered all four of them while funding their buy-sell agreement, the business was able to continue on seamlessly after the partner’s death. The policy gave them the fast infusion of capital they needed to seek a replacement partner, fly him out for interviews and hire him within 30 days’ time.
That’s pretty remarkable. My friend, one of the remaining partners, said it best: “It’s unbelievable that we didn’t think we needed this in the beginning. When we didn’t have any assets or profit, we didn’t think we needed to have any agreements or insurance; I’m glad we changed our minds before it was too late.” When a partner passes away and the show must go on, a life insurance policy is one of the best tools for making sure it does. Now, are there other ways to fund a buy-sell agreement? Sure. But unless the business has substantial capital sitting in a bank account that isn’t already earmarked for other expenses (a pretty unlike scenario, right?), an insurance policy is just a practical choice for funding the agreement.
Every jointly owned business needs a buy-sell agreement, and a life insurance policy is one of the best ways to fund that agreement. Think of it as a sort of “will” for your business – a succession planning contract that will protect all of those involved so that the terms you agreed on in the beginning can be honored when it comes time for them to be tested. New business owners must understand: Those trying times will be inevitable.
Kraig Strom, CFP®, ChFC® is a Certified Financial Planner® at Team Financial Partners in Corona. He can be reached at 877-297-5851, or at www.PersonalPensionFormulation.com.
