Thomas J. Perrone, CLU, CIC
A Different Way to Protect a Business, Its Key People and the Owner’s Future
Business owners spend a great deal of time thinking about how to grow their companies. They hire employees, develop customers, build vendor relationships and continually look for ways to increase profitability.
But there is another question that deserves just as much attention:
What happens to the business if a key owner or key person dies unexpectedly?
A traditional buy-sell agreement can provide an answer when there are multiple owners. But there are situations where a different approach may be more appropriate—particularly when the objective is to create a mechanism for the company to purchase an owner’s or key person’s interest upon death.
One strategy discussed in this podcast is the one-way buy-sell agreement.
The concept can provide a business with a predetermined method for handling an ownership interest when an unexpected death occurs, while also potentially creating financial security for the business and the surviving family.
What Is a One-Way Buy-Sell Agreement?
A one-way buy-sell arrangement is essentially an agreement in which one party agrees to purchase an ownership interest from another party upon a specified triggering event, most commonly death.
The arrangement can be particularly interesting when a company has an important owner or key person whose continued involvement is critical to the business.
Instead of leaving the family, the business and the remaining owners to negotiate what happens after a death, the agreement establishes a process in advance.
That can provide something every business owner needs:
certainty.
The goal is not simply to create a legal document. The objective is to establish a coordinated strategy for:
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Protecting the business
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Providing liquidity
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Creating a method for transferring ownership
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Helping the deceased owner’s family receive value
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Retaining important employees or key people
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Avoiding a forced or poorly timed sale
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Providing continuity for customers, vendors and employees
Why Key People Matter So Much
The podcast discussion begins with a real-world situation involving a company and a particularly valuable key person.
The individual was considered extremely reliable and important to the organization. The company initially considered an executive-benefit arrangement as a way of retaining that person.
That raises an important point:
Key-person planning and business-transition planning are often connected.
A business may have an employee or owner whose knowledge, relationships, production ability or leadership makes that individual extremely difficult to replace.
If that person dies unexpectedly, the financial consequences can extend well beyond the person’s salary.
The company could lose:
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Customers
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Revenue
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Specialized knowledge
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Leadership
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Vendor relationships
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Employees
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Business value
That is why business owners should think about both retention and transition when evaluating their most important people.
The Connection Between Executive Benefits and a One-Way Buy-Sell
One of the interesting aspects of the strategy discussed in the podcast is the relationship between executive benefits and a one-way buy-sell arrangement.
An executive-benefit strategy may be used to help attract and retain an important employee.
But when the planning is coordinated with ownership and transition objectives, the same overall strategy can potentially address additional business concerns.
The key is to avoid looking at each financial strategy as an isolated transaction.
Instead, business owners should ask:
How does this strategy fit into the overall plan for the company?
A business may need to simultaneously:
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Retain an important person.
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Protect the company from the economic consequences of that person’s death.
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Provide an orderly transition of an ownership interest.
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Create liquidity for the person’s family.
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Maintain control of the business.
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Continue building business value.
A properly designed arrangement can bring these objectives together.
What Happens When an Owner Dies?
Without a plan, the death of an owner can create a difficult situation.
The deceased owner’s family may suddenly own an interest in a business they know little about.
The remaining owners may want to continue operating the company but may not have the cash to purchase the family’s interest.
The family may need liquidity.
The business may need time.
And everyone may have different ideas about what the ownership interest is worth.
That is a recipe for conflict.
A one-way buy-sell arrangement can establish the basic framework before the crisis occurs.
Rather than asking, “What do we do now?”, the parties have already determined what is supposed to happen.
Funding Is Just as Important as the Agreement
One of the most important lessons for business owners is that having a buy-sell agreement is not necessarily the same thing as having a funded buy-sell agreement.
An agreement can establish an obligation to purchase an ownership interest.
But where does the money come from?
This is where life insurance and other funding mechanisms may become important.
The podcast discusses arrangements involving life insurance, premiums, cash value and other planning considerations.
The basic concept is straightforward:
The funding should be designed at the same time as the agreement—not years afterward.
Otherwise, a business could have a perfectly drafted agreement but discover that it does not have the financial resources to carry out the transaction when the triggering event occurs.
The Family Has an Interest Too
Business owners sometimes focus almost entirely on what happens to the company.
But the owner’s family is also an important part of the equation.
Suppose an owner dies and leaves a substantial business interest to the family.
The family may now own an asset that is difficult to sell, difficult to value and difficult to manage.
The remaining owners, meanwhile, may need control of the business to continue operating it.
A properly structured buy-sell arrangement can potentially solve both problems.
The family receives value for the ownership interest.
The remaining owners or the business receive the ownership interest.
The company can continue operating.
That is the fundamental objective of transition planning:
Turn a potentially disruptive event into an orderly transaction.
The Importance of Starting Before There Is a Crisis
One of the recurring themes in business planning is that the best time to solve a problem is before it becomes a problem.
A death, disability, retirement or other unexpected event is not the time to begin discussing ownership.
The parties should already understand:
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Who buys?
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Who sells?
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What triggers the transaction?
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How is the value determined?
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How will the purchase be funded?
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What happens to the family?
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What happens to the business?
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What happens to the remaining owners?
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How will the arrangement be reviewed as the company grows?
These questions should be addressed while everyone is healthy, the relationships are good and the business is operating normally.
Business Value Changes Over Time
Another reason these arrangements need to be reviewed is that businesses change.
A company that is worth $2 million today might be worth considerably more several years from now.
Key employees change.
Ownership changes.
Debt changes.
The company’s cash flow changes.
The owner’s personal objectives change.
The insurance funding may change.
Therefore, a buy-sell agreement should not be treated as a document that is created once and placed in a drawer.
It needs to evolve with the business.
The Bigger Lesson for Business Owners
The one-way buy-sell concept illustrates a much larger principle:
Business planning should be integrated.
Growth planning, key-person planning, executive benefits, protection planning, retirement planning and transition planning should not necessarily be viewed as separate subjects.
They can be different pieces of the same business-planning puzzle.
A successful business owner needs to build value.
But building value is only one part of the equation.
The owner also needs to protect that value and eventually determine how that value will be converted into personal financial security.
That is why transition planning should begin long before retirement.
Questions Every Business Owner Should Ask
If you own a closely held business, consider asking yourself:
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What happens to my company if I die tomorrow?
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Who would purchase my ownership interest?
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Does my family know what would happen?
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Is there a written buy-sell agreement?
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Is the agreement properly funded?
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Has the value of the company been updated?
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Would the business have enough liquidity to complete the purchase?
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What happens to our key people if they die?
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Could the loss of a key person significantly reduce business value?
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Does our current plan coordinate business protection with ownership transition?
If you cannot answer these questions clearly, your business may have a transition-planning gap.
Conclusion
A one-way buy-sell agreement is not simply a legal document. It can be part of a broader strategy for protecting a business, providing liquidity, retaining key people and creating an orderly transfer of ownership.
The most important point is that the agreement and the funding need to work together.
Business owners work for years to create valuable companies. The next step is making certain that an unexpected event does not destroy the value they worked so hard to create.
The objective should be simple:
Build the value. Protect the value. And have a plan to transition the value.
That is what effective business transition planning is designed to accomplish.
About the Podcast
This topic was discussed on Building and Protecting Your Business Worth, hosted by Thomas J. Perrone, CLU, CIC, of New England Consulting Group, Inc. The podcast focuses on strategies and ideas designed to help business owners build, protect and transition their businesses while creating greater financial security for their future.
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