Ten Fatal Mistakes Business Owners Make – No. 6: Failure to Fund Your Buy-Sell Agreement

If you think that you have protected your family and your business because you have set up a buy-sell agreement, you may still be seriously mistaken.  Unless you have properly funded your buy-sell agreement, death of one of the owners may have destructive consequences.

Death of an owner is devastating, both for the family and friends of the deceased as well as for her business partners and the business itself.  Owners play a key role in the success of any business.  They oversee sales, human resources, research and development, collections, marketing, and all daily crises.  Losing an owner has both personal and business repercussions for the survivors.  Even in the best of circumstances, revenues often drop after the death of an owner.

For that reason, a buy-sell agreement should have a source of funding available to allow the surviving owners to purchase a deceased owner’s share of the business.  That funding generally comes through life insurance policies.

Insurance policies provide the funds that allow the company to continue operating uninterrupted after death of an owner.  The business does not need to dip into its cash flow when the business is at risk because of the loss of an owner, nor do the survivors have to borrow to fund the buy-out.

If the agreement is not adequately funded, it provides limited protection to the owners.  An inadequately funded buy-sell agreement is almost as bad as no buy-sell agreement.  Even if you purchased an adequate amount of life insurance when you set up the agreement, the life insurance may be grossly inadequate if the value of your business continues to grow.

The solution is to review your buy-sell agreement regularly with your legal counsel – at least every two to three years – to ensure that it still meets your ongoing needs.  Part of that review includes determining whether the buy-sell agreement is still adequately funded.  If the agreement is not adequately funded, an untimely death may force the survivors to sell the business at a loss to pay estate taxes or to pay off the estate of the deceased owner.

Be prudent.  Set up a buy-sell agreement, fund the agreement, and regularly review whether it still meets your needs.  A properly funded agreement will help your business boom.

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