Business Worth Experience
The logic was there, but the numbers were’t!
Bob and Jim skipped life insurance for their buy-sell agreement. Instead, they invested the premium dollars themselves at 7%.
It was easy to see why they would think they did. As the logic sounded reasonable: no underwriting, no sunk cost if nobody dies for decades, and they believed they could beat the insurance company’s return.
Here’s the problem — that’s an investment strategy, not a risk-management strategy. And death doesn’t wait for a portfolio to mature.
Even at a clean 7%, it takes 26 years to grow their side fund to today’s $2,000,000 buyout target. If either owner dies in year 1, 5, or 10, the survivor is stuck covering a shortfall that could top $1.5 million — right when the business just lost a key owner-operator.
There’s also a tax trap: their agreement was a cross-purchase, so any reserve built up inside the corporation must be distributed to the surviving owner before it can fund the buyout. That’s a dividend or compensation hit eating into the exact money meant to cover the deal.
We compared four funding methods — self-funding, a bank loan, business cash flow, and life insurance. On guarantees and cost, insurance wins every time.
Bob and Jim funded with insurance, on a budget that worked today, with room to grow it as the business grows. Like everything else in their business, it gets reviewed yearly.
The instinct to find an alternative to premiums isn’t wrong. Short-term, it can sound solid. Long-term, the numbers tell a different story.
Message:
Too many Business Owners and advisors don’t spend time looking at the whole picture with the most important facts being analyzed. Because of this, ultimate, the business owner may end up in a financial nightmare with no way out.
Have you ever funded a buy-sell with something other than insurance? What happened?
If yours isn’t funded yet — what’s holding you back?
Free Download: The Cheapest Way To Fund Your Buy and Sell Agreement: This is a very good guide about buy and sell funding.
