How a Buyout Agreement Could Save Your Business

Nabity Business Advisors with Dave Nabity

Do you have a plan in place in the chance of an unexpected death? Today I want to talk about why that is an important step to take for your business.

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If you own a business with a partner and you have not planned for a catastrophe, then you could end up creating a huge mess down the road if something should happen.
For example, if you own a company that’s worth $5 million and you and your business partner both own 50% of the company, then both of you would have $2.5 million in your estate. What happens if your business partner dies?
Say your partner, “Joe,” has a wife and four kids, and Joe dies suddenly. The stock that he owns will then be passed onto his wife, who will need every bit of that $2.5 million to take care of the family after Joe’s death. What if you don’t have the money to pay that amount?
One thing that you can do is have a note that says that in the event of your partner’s death, you will pay the $2.5 million estate to your partner’s family over a five- or 10-year period. The problem is that notes aren’t deductible, and the payments to your partner’s wife aren’t deductible, and it could create a huge cash flow problem for you and could put the company in jeopardy.
You need to have a buyout agreement that’s called a “buy-sell” agreement. That agreement will have a set price and terms that are agreed upon ahead of time that will enable the surviving partner to buy out the other partner’s share in the company in the event of their premature death.

Our company helps business owners figure this all out.

One of the important things to think about is having life insurance on each partner. You can go to a life insurance company and get an insurance policy that is equal to the amount of value that each partner owns (in this case, $2.5 million each) and make the other partner the beneficiary of that payout. Then, in the event of your partner’s death, the insurance will pay out to you, who will then turn around and pay the surviving spouse. Then the spouse will return that stock back to you.
Sometimes people think it’s a great idea to have the corporation be the beneficiary or the owner of the insurance policy. That can end up being a big mistake because depending on what type of corporation you have, there can be alternative minimum taxes on the money the corporation receives. You can also run into problems when getting the stock back that would cause you as the surviving partner to lose a substantial amount of money.
If you do the agreement and buy the stock from your partner’s spouse, then your basis will go up significantly. If you don’t do this correctly and you sell the company later, you stand to lose quite a bit of money in taxes.
Our company helps business owners figure this all out. We help you design the structure of what that buyout agreement should look like and can help you find the right insurance companies that fit your company’s need to able to insure each other and have the money to complete the buyout in the the event of an unexpected death.
You really want to plan ahead on this, so if you have any questions or you want to get this process started, give me a call or send me an email. We’d be happy to help!