Before consideration of funding a business succession agreement with life insurance, a business owner or set of owners should have a binding agreement in place to direct where and how the proceeds will be distributed. To expand even further, the business itself must be valued. It is critical that the method of valuation maintain a company value which is consistent with the company’s current economic position. Statistics show that a very low percentage of agreements accurately reflect a truly current value.
The most common form of valuation is known as the “agreed value” approach.
The idea is that each year following receipt of the company’s financial results, the owners will meet and agree upon either
1) a value per share; or
2) an overall company value.
This newly agreed-upon value is posted to a schedule attached to the buy-sell agreement. If any significant events occur in the following year, the current agreed value is used to determine the purchase price.
While the purpose is to keep the company value current, most business owners utilizing this approach fail to regularly update the most recent agreed value. Worse yet would be to have agreements in place without a back-up valuation method, such as an appraisal, should the agreed-upon value be out of date. The suggestion here is simple yet far-reaching: if the agreed-upon value of a business is more than two years old, an alternative back-up method should be followed.
Whether it is by formula, appraisal, or even book value, prudence dictates that relying on a single and potentially outdated method of valuation can be disastrous.
Finally, once the value or formula is in place and the agreement is finalized, the pennies-on-the-dollar funding approach using a life insurance policy (permanent or term), covering the owners, is a natural last step. It can guarantee the necessary funding dollars will be there!
Our Life Insurance Expert
James is a 40-year veteran of the life insurance marketplace in the Greater Chicago area. His career has included a 22-year association as a branch manager and senior account executive with Hartford Life, earning top national office and top national account executive designations, while qualifying for award-conference level in 20 of those 22 years.
Our value proposition is a simple one. Offer a thorough and cost-effective solution to business clients through careful analysis, consultation and implementation.
Contact James at info@GoCGO.com.