We recently had a Client with three equal partners in a business worth $6MM who had a Buy/Sell Agreement among the partners but had no funding mechanism. This exposed the partnership to a risk that if one of the partners passed away, the surviving partners would have to come up with $2MM on the spot to purchase the deceased partner’s share. Without this amount of cash readily available, they would need to take out a loan and pay it back with interest over time. If paid back over ten years, principal and interest could easily add up to $3MM. Operating with a 10% profit margin, the surviving partners would need to generate an extra $30MM of revenue over ten years just to break even with the loan, and will have to do this minus one partner. If this partner was a revenue producer, an unexpected death could easily cripple the business, even with a well-drafted Buy/Sell Agreement.
After consulting with Key Private Bank we identified this gap and recommended they fund their Buy/Sell agreement with life insurance. They were able to do that with a $2MM term life insurance policy on each partner for under $2,000 per partner per year. The solution accomplishes the following goals:
1) Guarantees a buyer;
2) Creates the right amount of liquidity at the exact time it’s needed;
3) Sets a fair selling price;
4) Mitigates financial problems (attorney fees, reduced creditworthiness, expensive buyouts, etc.); and
5) Maintains harmony with the partners and their families.
Ultimately the Client’s decided to utilize a permanent policy for around $13,000 per year per partner that they could ultimately take with them as a retirement benefit when they leave the company.
While this specific solution was tailored to a professional services firm that was not being sold, the same concepts can apply to a company preparing to sell itself. In cases where the management team will retain some ownership after sale to a strategic or financial buyer, the new owners can use this kind of life insurance to protect against having to raise funds to buyout the shares of a deceased executive or former owner. The insurance also can be used to provide additional retirement savings.
Key Private Bank is a division of KeyBank, NA.
