The Partner That Ruined the Business

timthumbIf you have a business with a partner or partners you need a fully funded buy sell agreement. It should be set up before any partners pass away, become disabled or find out they have cancer, diabetes, or other ailments that can limit workable solutions. Doing so is not only cost effective but it provides peace of mind.

Why? Do you want your current partner’s spouse and children as your new business partners? Nice enough people, but are they qualified and willing at the drop of a hat to run the business?

Moreover, what will happen to the value of the business if something happens to a partner? A business valued at $5 million can quickly drop to $2 million without proper planning.

Then what happens when a partner passes away, the estate is valued incorrectly and the IRS comes looking for more then what was paid in estate taxes by the heirs? I’ll tell you. Litigation with the heirs.

And of course, divorce never happens to business owners. In all of these scenarios, doing nothing ahead of time is a bad business decision. I can’t tell you how many calls I’ve made to owners who don’t have fully funded agreements. They’ll say, “I’m all taken care of.” But when you look at what happens to many businesses after a life event, you realize they were just blowing me off.

The real blow off was on them. They blew off serious business planning they never even thought about because they were busy running the business. Fair enough. But they can’t do that or bury their heads in the sand because they still need to address the complex issues that arise when life events happen. Otherwise, like it or not, a business may be forced to close.
The main reason owners want to have the agreement fully funded is because for most businesses, using cash on hand, a sinking fund or financing through a bank loan may be undesirable or unavailable as a solution. Therefore work with the right team to provide the best funding solution.

Now after you set this up, get back to marketing and selling!

 

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Life After Death for Partnerships: What Happens When a Partner Dies?

business-woman3Have you thought about what will happen to your business when your partner dies? If no other arrangements have been made, the partnership will no longer exist as a legal business organization except for the purpose of winding up its affairs.

When a partner dies, the survivors have only two alternatives: they must either liquidate or reorganize.

Liquidation usually is not a good solution. The business generally will have to be sold quickly and for only a fraction of the value it had as a “going concern.” In most cases, good will is lost entirely. Physical assets may bring little more than one-fourth of their true value.

Reorganization Scenarios

Reorganization generally is a better answer. The reorganization of a partnership usually follows ne of four scenarios:

1. Your partner’s heir(s) become new partners. This plan may or may not work. One or more of the heirs might be a minor, and few of the heirs, if any, will have been regular employees of our business. They may not have the knowledge and experience needed to be a partner.

2. Your partner’s heir(s) sell their interest to someone else. This means you may not have a say in who your new partner will be.

3. Your partner’s heir(s) buy your interest in the business. In most cases, the heirs simply can’t afford to buy the business. Even if they can afford to buy, they may not be willing to pay a price adequately reflecting the value of the business.

4. Your partner’s heir(s) sell their interest to you. This would be an ideal solution if the surviving partners can raise a sufficient amount of cash and if they can agree on the terms of the purchase with the heirs.

The best solution is to plan ahead for the sale of your business upon the death of a partner. This can be accomplished with a “buy-sell” agreement.

A properly structured buy-sell agreement can establish the business value and ensure the continuation of the business by the surviving owners. In addition, the agreement generally establishes a pre-determined price for the business, as well as provides the money to actually buy the business from the heirs.

Value Your Business

Many business owners have a difficult time determining a realistic fair market value for their business. Partners can use a number of valuation methods to estimate the value of their interest n the business. No one method will work in every case but one, or a combination of several, should serve the needs of most business owners.

No matter which method you use to value the partnership, there is one important factor you should keep in mind: The buy-sell agreement should make provisions for future valuations of the business – either through periodic updating or use of a formula. That is because a fair market value that is “just right” today may be too low next year and entirely inadequate in five years.

When partners devote the bulk of their time, effort and ability to the operation of a business, its fair market value usually continues to increase. This constant appreciation should be taken into consideration when valuing the business.

Plan For The Future

Planning today for the future of your business helps protects you, your partner and your families.

You know exactly what will happen if a partner dies…the purchase price, the funding arrangements, etc. It allows you to continue in business and provides the partner’s heir(s) with immediate cash. There may be life after death for partnerships – when partners plan ahead.

 

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Wills Are Not Enough for Business Owners

brand1-e1383682355561Most business owners will leave the business they own to their family in their will. Before those with large estates do that however they have a few important questions to think about and answer about that will. First, do their heirs have the money to pay the estate taxes on the value of the business? Next, do their heirs know what the business is worth?

Business Owners Need to Value the Business

The owners will need to find the answers to those questions because their heirs either don’t know what the value of the business is or aren’t interested in what it is. Here’s the challenge though, when it comes time to assess the value of the estate of the owner, the IRS will tell the heirs what the business is worth. Then they’ll want taxes paid on that value. Do they have the money to pay those taxes?

When it comes to the valuation process, naturally to avoid a higher estate tax bill the heirs will want the IRS to put a lower value on the business while the IRS will want to put a higher value on the business. Guess who usually wins out?

Many times heirs will have to sell homes, stock or other assets to pay that estate tax bill. Worst case scenario they may have to borrow money or even sue remaining partners to satisfy the IRS. This is not what the owners wanted to do to their loved ones and their former partners.

So how do owners figure out what their business is worth? The following are the most common methods used to value a business:

  • Book Value
  • Straight Capitalization Method
  • Capitalization of Earnings Method
  • Years’ Purchase Method
  • Discounted Future Earnings Method

Solutions with a Fully Funded Buy Sell Agreement

These methods of valuation answer the question of what the business is worth but leave another one unanswered. Namely, how do you set aside money to pay the estate taxes based on the value of the business?

In many cases the answer is, by setting up a guaranteed fully funded buy sell agreement (http://en.wikipedia.org/wiki/Buy-sell_agreement ).This is an agreement where the terms are laid out what happens to a business should something happen to one of the owners. As part of the agreement it looks to put a value on the business and determines a way to pay for it.

 Need for Updated Business Valuation

Here’s a challenge for business owners when it comes to valuing their business with the buy sell agreement. Simply put, the value changes. The business owners started 20 years ago is worth more today than it was 20 years ago.  And since most owners don’t know when they will create their estate for the IRS to value, they should look to update the value in their guaranteed fully funded buy sell agreement every few years or so. Remember the IRS will want taxes to be paid by the heirs based on what the business is worth and if the heirs don’t have the money to pay that estate tax bill, problems arise.

Are Heirs Qualified to Run the Business?

Finally, is a partner’s spouse or children qualified to take over the business if they pass away? Again, the buy sell agreement can spell out what happens to the business if one of the owners passes away. This even applies if the business is owned by one person.

Wills are a great way to start the process of transferring a business to loved ones and friends however there are a few gaps with it that can be filled by a guaranteed fully funded buy sell agreement. Working with a qualified and licensed insurance advisor and other team members can go a long way in filling those gaps.

 

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