The Cost of Funding Your Buy and Sell Agreement! Options!
Over many years I have experienced many business owners in total denial about the cost of funding their buy and sell agreements, thinking they can come up with the liability when the trigger of death occurs.
The four listed ways are compared below.
- Sinking Fund
- Life Insurance
Let’s take the one by one.
Cash: This is assuming the company has the cash at hand, idle. Rarely is this an option. Growing companies reinvest in their company and only keep enough cash reserve as needed.
Borrow: A company just lost a valuable member of the company. Most bankers would probably want to see how the company will fair after the death of a key person and would want to know how the liability which has just been created will affect the cash flow of the company before loaning more money. There probably is a good chance that outstanding line be pulled in by the bank (probably a covenant in the loan agreement).
Sinking Fund: Mostly just theory! In 48 years, I have never seen a company try to develop a sinking fund. If the company was putting money in the sinking fun, they are losing the opportunities this money could create by investing in the business rather than on the sidelines. Not reasonable as the actual amount of money needed is available should death occur prior to the target date of accumulation. The least appropriate method.
Life Insurance: At its simplest benefits, it is immediate, tax free and the funding level is immediately known. Also, the cost is only 17 cents on a dollar rather than the much higher costs of the other three options.
Summary: While we don’t know when a death or disabilitymay occur, the company should at least be prepared for this trigger. Today the price of life insurance is low-cost. There is no reason not to purchase at least temporary life insurance (10-30 years), such as term insurance. The cost of life insurance in the example is using cash value life insurance. Increased Sales To Fund Cost: Another measure of effectiveness of funding the buy and sell is to measure how much more in sales the company has to do to pay for the funding method.
Costs: Funding over 15 years.
Cash; 1,039,464 Loan: 1,306,085. Sinking Fund: 901,613 Life Insurance: 171,512
Also, what do you need to have in sales to pay for the method:
Example, with Life Insurance Cost, @20% profit, sales would be $857,560
With Cash: There would have to be $5,197,320