Having a Buy-Sell Agreement in place is critical when a business has two or more owners, but that’s only half the ball game. The other half is finding the money needed under the Buy-Sell Agreement to buy out the business interests of the departing owner.
Here are some possible sources of funds for the buy-out:
Personal Funds of Co-Owners. Having access to sufficient personal cash to buy-out the interests of a co-owner may or may not be feasible, depending on the co-owners’ individual wealth and the amount of money needed for the buy-out.
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Loans from a Financial Institution. Depending on economic conditions, banks may or may not be willing lenders, and interest rates may or may not be high. Banks also may fear that the loss of the departing partner will be detrimental to the future of the business, and therefore be reluctant to lend money. And collateral needed by the bank to secure the loan may already be tied up with other loan agreements held by the business.
Installment Payments by the Other Co-Owners or the Business. Under this scenario, a down payment would likely be made, with continuing payments over the next few years. The downside is that the full buy-out price is not available immediately to the departing partner, or his or her heirs. Further, there is default risk that not all of the rest of the payments will be made.
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Special Fund. Money out of earnings could be set aside by the business over time for the eventual purchase of a business owner’s share. However, if the money is needed early in the fund’s life, or if more than one buy-out is required within a short span of time to purchase more than one owner’s interests, there may not be sufficient funds.
Life Insurance. Life insurance is often used as a source of funds. The drawback is that these funds are only available upon the death of a co-owner. As the business grows in value, business owners should periodically adjust the amount of life insurance held.
A Buy-Sell Agreement is one of the most important documents that any business start-up can have when that business is owned by more than one person or by more than a husband-wife combination. Yes, the addition of this document adds to the initial start-up costs and, yes, it involves planning for negative events such as death or disability of an owner, divorce, bankruptcy, default and the like. These are pessimistic outlooks when the new owners’ thoughts are focused only on positive outcomes — a natural inclination because it takes optimism to start a business. But having a plan in place at the beginning when all of the owners are healthy and cooperating well can save significant cash and headaches later.
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Disclaimer: This Blog is for informational purposes only and is not to be construed as legal advice. If you have questions, please seek the advice of an attorney. An attorney-client relationship is not formed by reading this Blog. If you are interested in Wittenburg Law’s representation of you, you must contact Wittenburg Law for a determination of whether your matter is one for which Wittenburg Law is willing and able to accept representation of you.
Bonnie Wittenburg, Wittenburg Law Office, PLLC, 601 Carlson Parkway, Suite 1050, Minnetonka, MN 55305 952-649-9771 bonnie@bwittenburglaw.com www.bwittenburglaw.com
