When business partners embark on a joint venture, it is essential to have a buy-sell agreement in place. A buy-sell agreement is a legal agreement between partners that sets forth what will happen to the business if one partner experiences a significant life event, such as death or disability.
Typically, buy-sell agreements are structured around life insurance policies. The idea is that the surviving partner will use the payout from the insurance policy to buy out the share of the deceased partner`s business. But what happens if the partners do not want to rely on life insurance for their buy-sell agreement?
There are several reasons why partners may opt for a buy-sell agreement without life insurance:
1. Insurability: One partner may be uninsurable or have a medical condition that makes life insurance prohibitively expensive.
2. Cost: Life insurance policies can be pricey, and partners may not want to bear the additional cost.
3. Complexity: Depending on the size of the business and the number of partners, structuring a buy-sell agreement around life insurance can be a complex and time-consuming process.
So, if partners do not want to rely on life insurance, what are their options?
One option is to structure the buy-sell agreement around a promissory note. In this scenario, the surviving partner would agree to pay the estate of the deceased partner a predetermined sum for their share of the business. This amount would be paid back over time, with interest, much like a loan.
Another option is to structure the buy-sell agreement around a sinking fund. In this scenario, the partners would agree to put a predetermined amount of money into a fund each year. If one partner were to die or become disabled, the surviving partner would use the funds to buy out the share of the deceased partner`s business.
It is important to note that if partners do opt for a buy-sell agreement without life insurance, they must ensure that they have the cash flow to cover the costs of any potential buyouts. They should also consider drafting a comprehensive partnership agreement that outlines the terms of the buy-sell agreement, as well as other details such as how profits and losses will be distributed.
In conclusion, a buy-sell agreement is a critical component of any partnership, as it can serve as a safeguard against unforeseen life events. While life insurance is a common way to structure a buy-sell agreement, partners have options. By carefully considering their goals, resources, and limitations, partners can craft a buy-sell agreement that meets their unique needs and protects their business for years to come.