If you have some equity in a business in a business you own with other people, you should consider establishing a Buy Sell Agreement funded buy insurance.
What are the benefits ?
By using this strategy, you could:
- Enable the remaining owners to acquire your interests in the business in an orderly manner if you die or become disabled, and
- Ensure you (or your estate/dependents receive adequate financial compensation.
How does this strategy work ?
If a business owner dies, in the absence of any specific arrangement, their interest Is likely to be:
- Distributed in accordance with their will (eg to their surviving spouse), or
- Otherwise controlled by their beneficiaries (eg if the interest is owned via a family trust).
As the new-part owner of the business, the spouse (or beneficiaries) would then be entitled to the same management and financial rights as the deceased owner.
But the remaining owners may not be happy admitting the deceased owner’s spouse (or beneficiaries) into the business and ownership disputes could arise.
The deceased owner’s spouse (or beneficiaries) might not have the necessary skills to assist in running the business, or even want to be involved.
Furthermore, the remaining owners may not be able to raise enough money to buy the departing owner’s equity in the business, nor agree on the price.
Potential problems can also occur if a business owner becomes disabled and is unable to work in the business again.
To protect the business and ensure an orderly transfer of ownership, a Buy Sell Agreement should be considered as part of the broader succession planning process.
A Buy Sell agreement is a legal contract between business owners that usually comprises two components;
- A transfer agreement *that outlines what will happen to each owner’s business interest if certain events occur and how the interests will be valued, and
- A funding agreement that outlines how the money will be raised to finance the ownership transfer and who will receive it.
There are a number of ways a Buy Sell agreement can be funded. For example, the remaining owners may be able to buy out the departing owner’s interests using their own capital or borrowed money.
However, when it comes to death and disability, insurance is usually considered the most cost-effective and efficient way to raise sufficient capital.
Note: While a Buy Sell agreement will be less important for businesses in which little equity is held, its still important that the owners of such businesses establish a broader succession plan.
“MLC Protecting business owners Smart strategies guide”
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