You are a group of successful entrepreneurs who have worked hard to grow your business into a successful enterprise. This asset now represents a significant part of your wealth and you want to ensure that your investment value and the business itself are protected for the future.
The Problem
If your business loses an owner suddenly, the remaining shareholders must decide how the business will continue. What are your options?
Generally, you have four options;
- Close down the business. This doesn’t seem attractive after all the time, energy and money that you’ve put into building it, not to mention the welfare of your employees.
- Continue the business with involvement from the new shareholder (for example, the spouse of the deceased), but do they know anything about your business?
- Sell your shares, but who will buy them and at what price? This seems unlikely given that your business has just lost a key shareholder.
- Purchase the shares from the deceased owner’s estate.
The Buy-Sell Agreement
A shareholders agreement with a buy-sell provision is the best solution as it provides a framework for the death, disability or retirement of a shareholder. The buy-sell agreement will address all of the following issues:
- Who buys the shares,
- The terms of the sale,
- When the sale is to take place,
- Source of money to buy the shares, and
- An equitable method for determining the purchase price
Generally, a mandatory buy-sell agreement is best for all stakeholders, as it provides protection for both the deceased’s family and the surviving shareholders. However, a suitable funding strategy is critical to the agreement’s success. There are a number of ways to fund a buy-sell agreement:
- Start saving today (sinking fund),
- Borrow the funds from a bank,
- Fund the buyout out of after-tax business profits,
- Sell assets, or
- Purchase life insurance and disability insurance for pennies on the dollar
The Best Solution
In almost all cases, insurance is the most cost-effective solution to fund a buy-sell agreement upon the death or incapacity of a shareholder, while also guaranteeing that the required funds are available precisely when they are needed.
This article was prepared by David Mason who is a mutual fund representative with Investia Financial Services Inc. This is not an official publication of Investia Financial Services Inc. The views (including any recommendations) expressed in this article are those of the author alone and are not necessarily those of Investia Financial Services Inc.
