What if your business partner died tonight?
It is difficult to imagine, especially after working so hard and long together, but it is quite probable that a business partner might suddenly die, long before either of you had planned to retire.
In the wake of such an unfortunate event, businesses are liable to fall apart if the proper planning and agreements are not in place. You can prevent losing all that you worked so hard together to achieve with a little forethought and effort.
First, you need to ask yourself a few key questions.
- If my partner suddenly died—what would happen to the business?
- How would this affect our families?
- Will there be conflicting priorities and future plans for the business between you, other partners and the deceased's family?
- Will suppliers and creditors extend the same credit and terms of business they always have or will they begin to pull back?
- Will customers maintain their confidence in your products and services?
- Will important employees suddenly begin to leave?
After you’ve asked yourself these and related questions, you can then begin to create (or revisit, if you already have an agreement in place) a legally binding contract that spells out exactly what you and your partner(s) want to happen if any of you dies.
The document itself can be as simple or complex as needed and can provide for virtually any contingency.
Following is a brief summary of the more common options when a business partner dies.
Four basic choices
Liquidate the business and distribute the remaining assets
Considering all your investment of time and money, as well as your sudden loss of steady income, this may be your least favorite choice. Moreover, depending on the market and the economy, you have to accept that your business and its assets could sell for a lot less than they are worth.
Take on your late partner's heirs as new associates
This option could also be problematic, especially if the heirs are not as passionate, experienced or willing to negotiate as your partner was.
Sell out to the heirs
Unfortunately, this option can lead to a lot of disheartening haggling of the purchase price and a lot of other heartbreaking considerations that you know your partner would never have allowed.
Buy out the heirs' share of the business
Often, this is the most practical choice. However, you still have to negotiate price and terms, and then come up with the money. This is where a buy-sell arrangement can help during this difficult time.
A properly arranged and funded agreement is a legally binding contract that spells out exactly what is to happen if one of the business's owners dies. The document itself can be as simple or complex as needed and can provide for virtually any contingency. However, it generally calls for the survivors to buy — and their heirs to sell — the deceased owner's share in the business. Just as important, it should spell out the actual purchase price or, more commonly, provides an objective formula for determining the price when needed.
Methods of funding available
Option 1: Wait and pay cash
In this option, surviving owner(s) use cash at the death of a co-owner to fund the buy-sell agreement. But, several drawbacks to this method exist.
- At death, funds may not be readily available for payment.
- A savings plan accumulates funds over time. What if funds are needed tomorrow?
- Will a savings plan be depleted to pay for unforeseen expenses?
- Accumulation of cash may cause an accumulated earnings tax problem.
- Future growth may be slowed due to an increase in expenses (repayment of loan).
- Death of an owner may cause sales to decline, compounding the problem.
- Death of an owner may make it difficult to receive a loan.
- A surviving owner may have to sign for funds, exposing personal assets.
- Surviving owners pay dollar for dollar plus interest for the deceased's outstanding share of the business.
- Immediate availability of proceeds when death occurs.
- Death benefit proceeds are generally federal income tax free.
- Premiums may be lower than the cost of repaying the loan interest.
Option 2: Wait and borrow funds
In this option, surviving owner(s) borrow funds, usually bank loans, at the death of a co-owner to fund the buy-sell agreement. But, much like the first option, this method has drawbacks.
Option 3: Life Insurance: Purchasing insurance can be a cost effective funding option for a buy-sell agreement. Using insurance as a funding vehicle will provide the following benefits:
Whatever option is best for you, it helps to have all the facts before making a decision. Your legal and tax advisors, along with a qualified insurance professionals can help you create an arrangement that best fits your needs.
This material is for informational purposes only. Neither New York Life nor its agents provide tax, legal or accounting advice. Please consult your own tax, legal or accounting professional before making any decisions.