A buy-sell agreement can establish what happens when an owner dies, becomes disabled, retires, or otherwise leaves a business. But an agreement alone does not create the money needed to complete the transaction.

The remaining owners may need to purchase the departing owner's interest. The departing owner's family may depend on receiving the value of that interest. And the business may need to continue operating without disrupting its financial stability.

The question is not simply whether you have a buy-sell agreement.
The question is: Is the agreement properly funded?

Dan Parrish Insurance Services helps business owners and their advisors evaluate the funding behind buy-sell agreements and determine whether existing insurance and financial strategies continue to align with the agreement and the owners' objectives.

We don't start with a product. We start with the obligation.

What Is a Buy-Sell Agreement?

A plan for what happens when an owner leaves.

A buy-sell agreement is a legal agreement that establishes what happens to an owner's interest in a business when a defined triggering event occurs.

Depending on the agreement, triggering events may include:

A properly designed agreement can help establish:

1. Who can purchase the ownership interest
2. How the interest will be valued
3. When the transaction occurs
4. How the purchase will be funded

The legal agreement is typically developed by the business owner's attorney.

Our role is to help evaluate the financial and insurance components supporting the obligation.

The Funding Gap

Having an agreement doesn't mean you have the money.

This is one of the most important distinctions in buy-sell planning.

Imagine a business has three owners. One owner dies. The agreement says the remaining owners must purchase the deceased owner's interest for $5 million.

The agreement may clearly establish the obligation. But where does the $5 million come from?

• The remaining owners may not have sufficient personal liquidity.
• The business may not have sufficient cash.
• Borrowing $5 million may not be practical.
• And the deceased owner's family may need the proceeds relatively quickly.

That's the funding gap.

The Buy-Sell Funding Gap

1. Owner Owns 50% of the business
2. Triggering event Death / Disability / Retirement
3. Buy-sell agreement Requires ownership interest to be purchased
4. Funding Life Insurance | Cash | Financing | Other Assets
5. Two outcomes Family: Receives value. Business: Ownership continues.

The agreement creates the obligation. The funding makes the obligation possible.

Why Buy-Sell Funding Matters

An unfunded or underfunded buy-sell agreement can create significant financial pressure at an already difficult time.

Without adequate funding, the parties may face:

The purpose of funding is to provide a source of liquidity when the triggering event occurs.

Life Insurance & Buy-Sell Agreements

Why is life insurance often used to fund a buy-sell agreement?

Life insurance can provide a source of liquidity when the triggering event is the death of an owner.

For example:

1. Owner dies
2. Life insurance proceeds become available
3. Proceeds provide liquidity
4. Remaining owner(s) purchase the deceased owner's interest
5. Family receives value for the ownership interest

The exact structure depends on the type of buy-sell agreement, ownership arrangement, number of owners, policy structure, and legal and tax considerations.

Life insurance is not appropriate for every situation, but it can be an important funding tool when the obligation is tied to an owner's death.

Cross-Purchase vs. Entity-Purchase

How is the buy-sell structured?

The funding strategy should match the legal structure of the buy-sell agreement. Two common structures include:

The appropriate structure depends on the specific circumstances and should be coordinated with the client's attorney, CPA, and other advisors.

Is Your Agreement Still Properly Funded?

A buy-sell agreement should be reviewed as the business changes.

A common mistake is creating a buy-sell agreement and assuming the planning is finished.

But businesses change. Owners change. Values change. Insurance policies change. Debt changes. Family circumstances change.

And the amount needed to fund the agreement can change significantly.

A funding review should consider:

The question is:

If an owner died tomorrow, would the current funding actually be enough to carry out the agreement?

When the Business Value Increases

A $5 million buy-sell agreement doesn't help much if the business is now worth $15 million.

Business owners sometimes establish insurance based on a valuation that made sense years ago. But if the company grows significantly, the funding may no longer match the obligation.

For example:

The agreement may still be valid. The problem is that the funding may now cover only half of the expected obligation.

That's why buy-sell funding should be reviewed as business value changes.

Valuation & Buy-Sell Funding

How much insurance is actually needed?

Determining the appropriate amount of funding is not simply a matter of choosing a number. The planning should consider:

The buy-sell agreement should define how the business interest is valued. The insurance strategy should be designed with that obligation in mind.

The legal agreement and funding strategy need to work together.

If an Owner Becomes Disabled

Death is not the only triggering event.

Life insurance can address a buy-sell obligation created by death.

But what happens if an owner becomes disabled?

Depending on the agreement, disability may also trigger a purchase obligation. The funding strategy may need to consider whether there are resources available to fund that obligation.

Potential strategies may include:

• Disability buyout insurance
• Existing business or personal assets
• Financing
• Installment payments
• Other liquidity arrangements

The appropriate approach depends on the agreement and the circumstances.

Buy-Sell Funding & the Owner's Family

The business may be the family's largest asset.

When an owner dies, the family may suddenly own an interest in a business they do not operate. The buy-sell agreement may require that interest to be purchased by the remaining owners or the company.

That can provide an important benefit:

The family receives liquidity instead of being left with an illiquid business interest.

For the remaining owners, the transaction provides a path to consolidate ownership. For the business, it can provide continuity. For the family, it can provide financial resources when they may be needed most.

Family-Owned Businesses

What happens when the owners are family members?

Family businesses can have especially complicated ownership arrangements. A buy-sell agreement may need to address what happens when:

• One sibling dies
• A parent retires
• A child wants to leave
• A family member becomes disabled
• An owner wants to sell
• Ownership passes to an heir who does not work in the company

The funding strategy should consider both the business's need for ownership continuity and the family's need for liquidity and fairness.

Learn more about Family Harmony & Governance.

Construction Companies

For contractors, the financial impact can extend beyond ownership.

For construction companies, an ownership transition may also affect:

That means buy-sell funding should be considered within the larger financial structure of the company.

A properly funded agreement can help reduce the need to unexpectedly pull capital from the business following an owner's death.

Learn more about Surety Bonding & Working Capital Protection.

How DPIS Approaches Buy-Sell Funding

Review the agreement. Identify the obligation. Evaluate the funding.

1. Review

   We begin by understanding the existing buy-sell agreement and ownership structure.

2. Identify

   We determine what financial obligations could arise from the agreement.

3. Evaluate

   We review existing insurance, coverage amounts, ownership, beneficiaries, policy performance, and funding.

4. Compare

   We compare the current funding with the potential obligation.

5. Identify Gaps

   If the funding does not appear aligned with the obligation, we identify the potential gap.

6. Coordinate

   We work alongside the owner's attorney, CPA, CFO, lender, and other advisors.

7. Review Over Time

   The strategy should be revisited as the business, ownership, valuation, and agreement change.

Questions Business Owners Should Ask

• Do we have a buy-sell agreement?
• What events trigger the agreement?
• How is the business valued?
• What is my ownership interest worth today?
• How much liquidity would be required if I died tomorrow?
• Is the buy-sell agreement adequately funded?
• Does our life insurance coverage match the current business valuation?
• Who owns the insurance policies?
• Who receives the proceeds?
• Are the policy beneficiaries correct?
• What happens if an owner becomes disabled?
• What happens if an owner retires?
• What happens if an owner wants to leave voluntarily?
• What happens if the business value increases significantly?
• Have the agreement and insurance been reviewed together?
• Does the funding strategy still match the ownership structure?

These questions can reveal gaps long before a triggering event occurs.

Why Dan Parrish Insurance Services?

The agreement is only half the plan.

A buy-sell agreement establishes an obligation. Our role is to help evaluate whether the financial resources supporting that obligation are still appropriate.

We work alongside the professionals who structure and advise the business, including:

• Attorneys
• CPAs
• CFOs
• Lenders
• Estate Planning Advisors
• Other Business Advisors

Our focus is on connecting the insurance and financial strategy to the legal agreement and the actual financial needs of the business owners.

We don't start with a product. We start with the obligation.