Business contingency planning and buy-sell agreements

By Hayes Parnell III

It’s the first week of a new year and a new decade. It doesn’t seem that long ago when the year, decade, and millennium changed overnight. Remember Y2K? All of the media hype and computer scares over how computer code stores and reads dates caused many industries to spend millions of dollars on new computer programs to fix the dates if Y2K caused them to freak. What happened? Basically nothing. Millions of dollars spent and millions of labor hours exhausted on preparing for an event that we were not sure would even occur. What a waste of time and money that was in retrospect. And what lessons we can learn from that experience. For example, we now know the importance of contingency planning on a large scale. Problem is, contingency planning for Y2K was left for anyone and everyone’s imagination to conjure up world-wide disaster scenarios and engineer brilliant solutions to them and, by the way, profit from those solutions.

So where am I going with this? Contingency planning for your business! If Y2K taught us contingency planning on a world-wide scale, we should now be able to plan for contingencies in our businesses. What steps should you take? Determine what elements of human and financial resources combined with the optimal levels of products and services your business needs to produce its dead-level best performance ever. Then, think of everything that could interfere with reaching this level of performance and label each a performance interrupter. Finally, design a contingency plan that will bypass each performance interrupter and put your business’s performance back on track.

A major part of business contingency planning is implementing a plan for your business to continue without interruption should business owners or key managers unexpectedly die. Buy-sell agreements are used to purchase a deceased partner or owner’s percentage of the business. This provides the deceased partner or owner’s survivors with financial support for their future and ensures other business employees that the business will continue to operate, even after the loss of a key person in the company.

If you’re a partner or co-owner of a business, you’ve spent years building a valuable financial interest in your company. Establishing a buy-sell agreement to ensure your surviving family a smooth sale of your business interest is important. Let’s discuss some types of buy-sell agreements and ways to fund them.

The three basic types of buy-sell agreements are: entity purchase, cross purchase, and wait and see purchase.

In an entity purchase buy-sell agreement, the business itself buys separate life insurance policies on the lives of each of the co-owners. The business usually pays the annual premiums and is the owner and beneficiary of the policies.

In a cross purchase buy-sell agreement, each co-owner buys a life insurance policy on each of the other co-owners. Each co-owner pays the annual premiums on the policies they own and are the beneficiaries of the policies.

A wait and see buy-sell agreement combines features from both the entity purchase and cross purchase models. The business can buy policies on each co-owner, the individual co-owners can buy policies on each other, or a mixture of both methods can be used.

One of the best methods used to fund buy-sell agreements is life insurance. The life insurance that funds your buy-sell agreement will create a sum of money at your death that will be used to pay your family or your estate the full value of your business ownership interest. If the value of your business grows over time, the insurance proceeds could be less than the value of your business interest, causing your surviving family members to get less than full value for your business interest. Because of this, you should specify how the valuation difference will be handled. Should the insurance proceeds be greater than the value of your business interest when you die, you should have addressed this potential situation upfront to specify whether the excess funds will belong to the business, the surviving co-owners, or your family or estate. Either way, if all goes well, your family gets a sum of cash they can use to help sustain them after your death, and the company has ensured its continued operation.

Consult your friendly home town banker to assist you with business contingency planning, business entity selection, business financing, and professional referrals for the purchase of all business-related insurance products.



-Hayes Parnell III is the chairman and founder of Covenant Bank.

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