Here at BW Private Wealth we are a local family Financial Planning business and do a lot of work with other local businesses of all types.
Something that comes up a lot is a business that has been set up and may or may not have a buy/sell agreement.
When a business first starts, it may not be as crucial because the business is probably not worth a lot and isn’t earning a lot… yet.
Most people want their business to get to the point that it is worth more and more, and the bigger we grow the more people that will become involved.
You may start your business with a friend or family or as you grow you might get to the point where someone joins the business and buys a portion of you.
At this point, it is paramount that each party looks at a buy/sell agreement and the insurance that entails.
This means if something was to happen to one of the owners the insurance would allow the business to buy the portion back from the owner or estate. This can include Life, Total and Permanent Disability (TPD), Trauma, and/or Income Protection.
Case Study:
John has a successful plumbing business and it has had really good growth.
He has had a conversation with one of his longtime employees, Samantha, who would like to look at buying a portion of the business to help it grow as well.
John is happy with this as he would like to start to take a step back from work anyway.
They started by getting the business valued and it was valued at $10,000,000.
John and Samantha have agreed for her to buy 20%, or $2,000,000, of the business.
She has had to get a substantial loan to buy into the business.
2 years later John gets very sick and has to leave the business due to this illness.
The business has now been valued at $12,000,000.
This means Samantha now needs to find $9,600,000 to pay out John for his 80% of the $12,000,000.
She has a couple of options (assuming she doesn’t have the capital available):
Try and find someone, or someone’s, to buy into the business to cover the 80%. This will be handing over a substantial portion of the business to a fire sale;
Or, Try and get another loan for the amount required;
Or, the estate takes ownership of 80% of the business until it is paid out.
This could have been avoided if Samantha and John organized insurance within their buy/sell agreement. Under these circumstances John would have likely been able to make a TPD and/or Trauma claim. This claim would have covered his portion of the business and Sam would have taken over 100% of the business.
This example is obviously on the extreme side of things, but the same goes for a $100,000 business. Finding 80% of that might not be an easy proposition whilst trying to run the business.
This is a crucial, but often overlooked, part of being in a partnership.
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