Week 4: Funding Strategies for Buy-Sell Agreements

Final Article in the Business Insurance Series

Why Funding Matters

A Buy-Sell Agreement defines the “who” and “how” of ownership transfers. Funding determines “when” and “with what resources” that transfer occurs. Without a clear funding plan, even a well-drafted agreement can leave owners scrambling for cash and delay transitions.

Common Funding Methods

1. Life Insurance Policies

• Business or owners purchase life insurance on each covered owner.

• Death-benefit proceeds supply immediate liquidity for a buy-out.

• Often paired with cross-purchase or entity purchase structures.

2. Sinking Fund (Cash Reserve)

• Business sets aside profits over time into a dedicated account.

• Accumulated cash is used to purchase a departing owner’s interest.

• Requires discipline and sufficient ongoing cash flow.

3. Installment Sale

• Departing owner agrees to receive payment over a series of installments.

• Reduces upfront capital requirements for buyers.

• Interest and principal payments may extend beyond one year—consult tax advisor.

4. Hybrid Approaches

• Combine life insurance with sinking funds or installment terms.

• Tailor to cash-flow cycles, tax planning, and ownership goals.

Factors to Evaluate

• Impact on Cash Flow
  • Life insurance premiums versus annual sinking-fund contributions
  • Installment payments’ effect on operating budgets

• Tax Considerations
  • Death-benefit proceeds are generally received income-tax free
  • Interest on installment payments may be deductible—review with tax counsel
  • Cash-reserve earnings may trigger corporate tax events

• Administrative Complexity
  • Multiple policies require ongoing underwriting and premium payments
  • Sinking funds demand formal bookkeeping and governance
  • Installment agreements need clear documentation and default provisions

• Alignment with Succession Goals
  • Liquidity timing: immediate payout versus extended payment schedule
  • Ownership impact: full transfer at death versus phased acquisition

Action Steps for Business Owners

1. Inventory existing Buy-Sell Agreements and funding provisions.

2. Model cash-flow projections under each funding method.

3. Consult legal and tax advisors to confirm regulatory compliance and tax treatment.

4. Select or combine funding methods that align with your ownership structure and financial projections.

5. Schedule an annual review to adjust funding targets, premium amounts, or installment terms.

Thank you for following our Business Insurance Series. With these funding strategies in place, your Buy-Sell Agreement becomes an actionable plan—ready to facilitate ownership transitions without disrupting operations.

Investment advisory services offered through Redhawk Wealth Advisors, Inc., an SEC Registered Investment Advisor. SEC Registration does not imply any level of skill or understanding. Redhawk Wealth Advisors and Patten Financial Group are unaffiliated and separate legal entities.