By Jacob J. Rehm, CLU, RPLU jrehm@profinsprog.com
How would a death or disability affect your practice? When these events occur, your practice could be significantly impaired or forced to close in a short period of time, not because you did something wrong, but because you did nothing.
A properly funded buy-sell agreement can help solve this problem. This agreement is a legal contract that obligates surviving owners, or the practice itself, to buy out the interest of an owner who dies or becomes disabled. It’ll also help establish the value of the practice and how the agreement will be funded. The agreement also guarantees that there will be a ready market for your practice interest should you die, become disabled or otherwise leave the business.
There are two common ways to structure a buy-sell agreement involving life and disability:
- The Cross Purchase: This would involve the co-owners owning life/disability on each other and would require the surviving owner to buy out the interest of the deceased or disabled partner.
- The Entity Purchase: Similar to the cross-purchase, except the company is the one obligated to buy out the interest of a deceased or disabled owner. For corporations, this is also commonly referred to as a stock redemption plan.
Options for funding of Buy-Sell:
- Reserves: Maybe your practice has cash reserves it could dip into to fund this agreement. However, this is very often unrealistic and the funds available aren’t enough to cover the buy-out.
- Borrowing: Typically this is the most expensive and least practical solution. That is if you can even obtain funding after losing one of the key revenue generators of the practice.
- Installment Sale: Like reserves, a rather impractical option that would also eat up much-needed cash flow.
- Insurance: The most practical solution for funding any buy-sell. Benefits are paid when the policy is triggered and your ensured funds are available to complete the purchase.
Benefits of a properly funded buy-sell:
- Turns your ownership into a liquid asset.
- Establishes the value of your practice.
- Prevents unwanted changes in ownership.
- Establishes the value of your practice for estate planning purposes.
- Identifies future buyers of the business and establishes a ready market.
- Identifies the specific events that will trigger the agreement.
To guarantee your practice remains strong, even after the loss of a partner, requires proper planning through a properly structured and funded buy-sell agreement. Consulting with your insurance advisor, business attorney and tax adviser is the only way to assure you address all potential concerns and choose the proper plan structure!