Peace of mind for partners

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Kenneth Dewitt is a CPA and certified financial planner who serves as a part-time chief financial officer for a variety of businesses, including trucking companies.

Trucking companies often have co-owners or partners, each of whom is critical in some way to the financial success of the venture. Rarely can the partners answer these questions: What happens when one owner wants out? What happens when an owner retires, becomes disabled or worse? Will the company survive such a contingency? Typically, the business is thrown into financial and operational turmoil, because the owners were “too busy” to set in place a buy-sell agreement.

A buy-sell agreement is an arrangement that anticipates that one or more partners ultimately will leave the business. Buy-sell agreements involve both legal and financial elements and, done properly, require the services of both an attorney and an accountant.

There are at least five circumstances under which an owner departs the business: (1) transfer of a stake to another partner; (2) disability; (3) retirement; (4) death; or (5) sale or dissolution of the company. A buy-sell should anticipate the financial obligations that would arise from each of these eventualities.

Start by fixing a value on your business, which you should do periodically anyway to assess your company’s financial situation. Business valuation involves either using an agreed-upon formula or hiring an expert to do a business appraisal. The formula can be simple and tied to your financial statements, such as “five times net earnings,” but that approach won’t reflect recent developments in your business or future prospects. A formal business appraisal is more expensive – perhaps $4,000 to $10,000 or more – but it can assess all circumstances, such as new contracts or anticipated future results.

You will need an appraisal anyway should an owner die with a total estate, including home, personal assets, retirement plans, insurance and business interests, valued at more than $1 million. In that case, an appraisal would have to be attached to the deceased’s estate tax return.

Suppose a business has two 50/50 partners, a gross value of $10 million and debt of $8 million, leaving a net value of $2 million. Suppose also that the partners had agreed that in case of death the other would buy the rest of the business from the deceased’s estate. A surviving partner therefore would have a $1 million obligation to the estate. How could he finance this? A 10-year payout at 7 percent would be more than $11,600 per month!

The buy-sell first anticipates the death of one owner. Cross-coverage of insurance makes the most sense, with each owner buying a policy on the other. Careful ownership planning is required to ensure that the beneficiary receives the policy tax-free.

You should purchase more insurance than just what you need for the buyout. Some companies add 25 percent to 50 percent more than anticipated. The additional funds go to help recruit and replace the lost partner’s talent by searching for new key employees.

Short-term and long-term disability can also be covered in part by insurance. Unfortunately, many business owners overlook this critical coverage.

Suppose that a partner retires rather than dies. Obviously, there is no life insurance to help. So you need to begin thinking about retirement of an owner at least 10 years in advance. That will allow the owner who doesn’t retire to set aside earnings into a fund or into permanent life insurance to help pay for the retiring partner’s interest. Alternatively, the owners could have ample time to look for a new partner to buy out the retiring one. One of the most difficult situations is when a partner suddenly wants out of the business, and there has been no financial or managerial preparation.

Whatever your company’s circumstances, it is a certainty that over the life of your business, one or more ownership-changing events will occur. It only makes sense to plan for this now while everyone is getting along as friends, rather than later when your options are fewer.

CCH Business Owner’s Toolkit has an excellent series of online articles giving background on buy-sell agreements. Begin your review at this site.