Buy/Sell Basic Questions

[Bob_The_Insurance_Guy]

If someone is exploring purchasing buy/sell insurance, what key questions should they ask themselves (and their partner) to figure out what features they need? I know it varies, depending on industry. Just wanted to get some feedback from the experts here.

 

[Larry Tew]

If someone is exploring purchasing buy/sell insurance, what key questions should they ask themselves (and their partner) to figure out what features they need? I know it varies, depending on industry. Just wanted to get some feedback from the experts here.

There are two parts. First, the buy-sell agreement. This is A LEGALLY BINDING agreement that the heirs of the deceased owner MUST sell, and the SURVIVING owner must buy. The life insurance death benefit is the funding for the purchase. A key benefit of the agreement is that it helps to lock in the value of the business so that at death there isn't a big haggling over the purchase price.



Usually for a small number of participants, a "cross-purchase" buy sell is done. Each owner buys, owns, and is beneficiary of insurance on the other owner(s). "A" dies. "B" owns policy on A. B gets proceeds and is legally bound to buying A's share of the business from A's heirs. Neither party can back out.

Maybe worse than not having a buy-sell is having an unfunded buy-sell. Now both parties are bound but there is no guaranteed money to pay with.

If there is some concern as to one of the owners "taking the money and running", a "Trusteed Buy-Sell" may be considered where a trustee actually handles the proceeds and sale.

There's also the "Entity" buy-sell for situations where there are too many owners to conveniently have a policy on every other owner. This approach can effect cost basis down the road when an owner decides to sell (maybe another issue).

If you have access to AMO (Advanced Markets Online), they have some decent visuals, and most life insurance companies should have material on buy-sells too.

 

[scagnt83]

Good response Larry.

Ditto on the cross purchase arrangement. Its rare to do an entity purchase with just two partners.


Some questions to ask:
-How much would you sell for right now? (sometimes throwing out dollar amounts helps; start small and go up)

-How much do you realistically think your biggest competitor would buy you out for?

-If things completely stopped tomorrow, how much would you need to wind the business down?

-If one of you dies, will the other continue the biz, or liquidate it?

-Is one more valuable than the other? Does one partner have a skill that cant be outsourced and the other partner does not have? (if so then thy may want to consider more on the skilled one if the other wants to continue the biz)


Often the old standard is 1-2x revenue, or 3-4x profit.



DONT FORGET LTD!!!
They are much more likely to be disabled than to die.
Principle has a great Key Man lump sum DI product; it goes up to 3x salary.
BOE policies can help in these circumstances too.

 

[tlmarketing]

I've targeted business owners and buy sell for years and never had an entity purchase plan, cross purchase seems easier for owners in most cases.

The owners need to ask each other:

1. What is the business worth today?
2. How do we account for future growth of business in the buy sell?
3. How often will we review this agreement to make sure we dont end up with an under funded buy sell agreement.
4. Are families of both owners aware that this plan is in place and funded? Avoids litigation and problems later when family learns they are no longer in the family business.
5. How are we going to account for premium differences? One partner is overweight, sick and table rated, the other is preferred best health.
6. How many policies do we need???? Dont forget the tried and true formula for cross purchase: x(x-1)= the number of policies to buy. "X" represents the number of owners.

 

[leeleerambles]

All of the answers you got are excellent. Here's one more scenario I'll throw out there, based on a recent situation I came across:

A business was owned by 3 partners, they had a buy-sell in place since 2001 when they formed. Then in 2010, one of the partners became terminally ill. Their last valuation had been done in 2006 when things were booming. The business had since crashed very significantly. The dying partner did not want to do a new valuation, nor did his wife, who knew she'd be inheriting his share. The other two partners tried desperately to get a new valuation done only to find they had no leg to stand on. There was no stipulation in the buy-sell of any expiry on a valuation. So for example, only stating in the buy-sell that a valuation SHOULD be performed annually (which it did) does not matter. It has to ALSO stipulate that in the event of none having been performed in X amount of time, the last one would be void, and a new one MUST be performed before any asset distribution is done.

In this scenario, the gentleman did pass, and his wife is a piece of work giving the other two partners a really hard time, demanding ridiculous sums of money and now lawyers are involved etc etc.

Anyways, in addition to the other excellent advice, I would mull this over.

 

[VolAgent]

Just to further expand on what Larry said. There are two parts to the buy/sell. The funding, usually insurance, and the binding document. There are plenty of horror stories of what can go bad when one piece is missing. The company that thought it would self-fund and now is defaulting on the buy out as the economy is bad. Also, the partner that took the money and ran because there was no legal agreement forcing him to buy out the widow.

 

[tlmarketing]

lee - if the buy sell was funded by life insurance at the higher valuation amount, why would the other 2 partners fight it if the terminally ill owner was going to be bought out using the policy proceeds anyway? the same would apply to them if they died, right?

 

[ims01]

Be certain to consider that in general valuations are down right now. Suggest that your clients buy enough insurance to overfund the Buy/Sell because hopefully the value will increase after Nov. 2012.

If your client is a Doctor's practice, Architects, etc, you should also suggest they get a Disability Buy Out. If one partner becomes disabled and unable to produce revenue for the partnership the others will want that partner out. A DBO will provide a lump sum after typically 12 months to allow the healthy partners to buy out the disabled partner.

 

[insurehound]

Sorry to come in late in the game, can someone explain how a business does indeed account for a large premium difference in a cross purchase situation? Example, a younger owner has to pay a much higher premium to cover his older, sicker partner.

Also, who actually does the valuation? Is it the agent? CPA? Attorney?

Lastly, who has the final say in what kind of agreement will be used. Example: Cross Purchase versus Entity Purchase versus Wait and See.

Being this is a newer venture for me, I'm having a hard time understanding where my role ends and other professional's roles begin.

 

[VolAgent]

Sorry to come in late in the game, can someone explain how a business does indeed account for a large premium difference in a cross purchase situation? Example, a younger owner has to pay a much higher premium to cover his older, sicker partner.

Also, who actually does the valuation? Is it the agent? CPA? Attorney?

Lastly, who has the final say in what kind of agreement will be used. Example: Cross Purchase versus Entity Purchase versus Wait and See.

Being this is a newer venture for me, I'm having a hard time understanding where my role ends and other professional's roles begin.

It could be just part of the cost for the younger guy. Of course he could look at it this way, since his partner is older and sicker, he is likely to have complete ownership sooner.

It depends on the value of the business. For smaller businesses, the insurer will often just take a stated value. For larger businesses that require larger policies, the insurer may want something from a CPA or business valuation specialist.

The prospect always has the final say, they don't have to buy anything. It is up to the agent to recommend a structure, which their CPA will probably give input on. You have to watch out for CPAs, a lot of them will try to recommend just cash flowing the buy-out. This kills your deal and screws the client if there is ever a cash flow crunch later on.

JMO, the less a CPA or attorney knows about insurance, the more conviction with which they recommend against it.