There is a multitude of ways to fund a buy-sell agreement but life insurance is probably the best option for small businesses. Here’s why.
Funding Buy-Sell Agreements
Cash
Funding a buy-sell agreement with cash requires the business or its owners to have and hold cash reserves. For an established business this may be an excellent option, but for newer businesses, not so much. Most of a business’s capital is usually tied up in inventory or other illiquid assets. Meaning the business probably doesn’t have the cash to set aside. Then it would fall on the remaining individual owners to fund a triggered event.
Loans
Business owners can fund buy-sell agreements with loans. The problem with using loans is that interest increases the actual buyout price. In addition to the fact that the business or remaining owners would need to obtain financing at a time when a triggering event may impact creditworthiness.
Installment Payments
Basically a form of seller financing, the seller, in this case, the deceased partner’s estate. The biggest con with this method is that if the company has a downturn in business, payments may cease.
Life Insurance
By far the best buy-sell agreement financing option. With a death benefit equal to the value of the percentage of the business owned, the death benefit guarantees sufficient funds for the remaining partner(s) to buy the deceased partners’ share.
You can use term life, whole life, universal life, variable life or a combination thereof. Whether the premiums have been paid for 1 month or 20 years, the full death penalty pays out. That makes life insurance the most financially responsible way to fund a buy-sell agreement.
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