By: Surety Life On: April 21, 2023 In: Insurance Comments: 0

A sound business plan should consider what would happen to the business in the event of an unplanned exit such as the premature death or permanent disability of a business partner.

Does your business require a buy sell agreement?

Consider the following privately held partnership business. This same could also apply to many private businesses with multiple owners.

  • Type of Business: Legal practice with two principals.
  • Annual Legal Fees $2.2 Million (turnover)
  • Partner share of Profit $450,000 Each
  • The business property is owned via a family trust structure and company trustee. Their spouses are the directors of the company trustee. The
  • property was purchased using a bank loan.
  • Property value $2 Million.
  • Bank loan for property purchase $1.4 Million.
  • Business Borrowings: $250,000 working overdraft.
  • Staff structure: Two equity partners and a salaried lawyer generate business income. They are supported by paralegal and administration staff.

At the death of a shareholder/partner, what options are available to a surviving shareholder/partner if the business is to continue?
Usually the following options are available.

  1. Wind up the business.
  2. Take in the deceased family as s ‘working’ shareholder.
  3. Do 100% of the work and split the profits with the deceased shareholder/partner.
  4. Hire a replacement – but still split profits with deceased’s family.
  5. Buy out deceased’s shareholding.

The partners both agree that a buyout will be necessary. Their spouses would not add any value to the business due to not being qualified and not having any experience.

Are the partners in a financial position to purchase an exited partners share?

The following options could be considered

  1. Borrow money from the bank against their home equity.
  2. Use savings or sell assets.
  3. Sell to a new partner (third party).
  4. Use life insurance to fund the purchase price.

The partners both agreed that using life insurance was the best option for the following reasons

  1. Borrowing money against their homes was an increased risk to their families.
  2. They did not want to sell assets or use savings which had been built up over many years and provided their families with financial security.
  3. The loss of a business partner could lead to a drop in revenue and loss of profits. The business might be worth less. The level of risk in the business could increase due to these factors.
  4. The life insurance funding would bring certainty to the surviving partner and the exited partners family. To achieve this a buy sell agreement will also be required.

The business partners both agreed that the life insurance premiums were affordable, and if anything was to happen, the insurance would help one of them purchase the business at a fair price and retain control of the business moving forward. The exited partners family would have received a fair payout and would not have to worry about any of the risks associated with the business

The next article will address, what is a buy sell agreement and how to organise one.