by Michael Goodman
For many professionals and small business owners, especially those involved in partnerships, a Buy/Sell agreement may be needed. These agreements are used when one of the partners, or a Key Man, dies and the remaining partners or owners do not want the heirs to become owners or partners. So the remaining partners, using a formula in the agreement, buy out the heirs and the business goes on without the deceased owner. The big question is where to get the money to compete this transaction?
In many partnerships, the business is the largest asset of the partners and the buy-out value of a dead partner may be substantial. If they don’t have enough cash readily available, they may have to find another partner to replace the one that died, they may have to liquidate other income-producing assets, or they might have to borrow the money and take on debt. Is there a better way?
Many partnerships and small businesses use life insurance and a third-party investor to put the funding in place before it’s needed. Life insurance policies are purchased on each of the partners and the premiums are paid by the investor, secured by the death benefit and the cash value.
Sometimes, additional business assets are needed to secure the loan for the premium but this is decided on a case-by-case basis. However, the partners do NOT have to provide personal guarantees. The business partners MAY have to make interest payments on the premiums, but that’s it, and the interest payments are often tax-deductible for the business.
By doing this, the partners have now secured money to buy out the heirs of any partner and will not have to use their own money. They don’t even have to pay the premiums, they just pay tax-deductible interest on the premiums. The insurance company sold a large policy, and the investor makes a highly-secured loan. Everybody wins!