By Jennifer Ortmeyer
For The Bellingham Business Journal
Owners of privately held small businesses in Whatcom County have plenty to worry about—employees, office space, equipment, taxes, you name it. But something that partners in most businesses put in place in an organization’s start-up phase—a buy/sell agreement—should be on their short list of items to periodically review and update as needed. As the business grows and changes, the agreement should keep pace with the changing needs of the partners and the business itself.
A buy/sell agreement dictates, among other things, what will happen to an owner’s share of the business if he or she is disabled or dies. It’s one thing to have a buy/sell agreement—typically drawn up by an attorney—but quite another to have one that’s current and is adequately funded.
Co-owners of many small businesses in Northwest Washington should ensure they’re adequately funding the buy/sell agreement they originally agreed to. The minority of small businesses that have no buy/sell agreement should strongly consider establishing one.
Buy/sell provisions triggered by an owner’s death are typically funded by life-insurance policies that are paid for by the business. If an owner dies, the buy/sell agreement typically requires that the business purchase the deceased owner’s interest in the business from his or her estate; the business must also use the proceeds of the policy to fund the purchase.
A buy/sell agreement can also address paying an owner’s salary if he or she becomes disabled, via a disability insurance policy that can cover a percentage of that salary.
It’s key to ensure that the buy/sell agreement and the related insurance requirements are in step with current realities, both personal and professional. The best way to illustrate the point is an example.
When the (fictitious) XYZ Company formed 20 years ago in Bellingham, partners Adam and Ben had no employees, the company had modest revenues and the owners paid themselves small salaries. Both Adam and Ben were married. All those factors affected their buy/sell agreement that covered who’s entitled to buy a departing owner’s share of the business, the price for that share and other variables.
As the years passed, however, the company’s sales grew to the point where today they have 60 employees and the owners’ salaries have quadrupled. By any professional measure, Adam and Ben have been a success—but, personally, the marriages of each partner ended in divorce.
Over the course of two decades, Adam and Ben have kept track of countless details relating to their business—but not the buy/sell agreement. Had they done so, they’d realize that their ex-spouses were still named in the buy/sell agreement and in their life insurance policies. They’d also notice that their original 10-year term life insurance policies are still in place, but they’re paying a much higher rate than necessary.
If Adam or Ben passed away, their ownership share of the business along with the insurance proceeds would pass to the ex-spouse. Sharing ownership and decision-making with a late partner’s ex-spouse is probably not a recipe for the business’s continued success.
In the example, there’s no problem unless a partner dies or becomes disabled. Of course, that’s the nature of insurance—after a fire occurs is not the time to increase the limits on a homeowner’s policy.
Owners of small businesses don’t need to be experts in buy/sell agreements or insurance to ensure that their current needs are covered. They can seek a review by a trusted attorney and insurance broker on a buy/sell agreement that was put in place years ago—or ask for their advice on developing and funding such an agreement if they’ve never had one. The potential benefit of a current, well-funded buy/sell agreement far exceeds the cost.
Jennifer Ortmeyer is employee benefits consultant at the Bellingham office of HUB Northwest, which provides general commercial insurance, group benefits insurance, surety bonds and risk management products.For more information, e-mail email@example.com, call 360.734.8025 or visit www.hubnw.com.