Welcome to 2023! I am Nader Ansary, VP of Advanced Markets. As the new leader of HUB’s ACES division, I look forward to adding value to your business. Over the last 20 years, my focus has been on assisting advisors in the large case market. I look forward to sharing many ideas and concepts with you as we grow together. In my short time back at HUB I am beginning to get a sense of what topics/concepts will be of interest to you. 

A topic of discussion that has come up many times since joining the HUB Team is “Shareholder Agreements.”

When two or more individuals are in business together, they may want to consider having a Shareholder Agreement in place. The purpose of a Shareholder Agreement is to provide clarity when implementing important business decisions, such as how directors are appointed, how shares can be transferred/sold, how to dispute disagreements, shareholder rights, etc. Without this written clarity, shareholders with differing opinions may end up disagreeing, potentially causing interruptions to their business.

For the purpose of this blog, we will focus exclusively on the Buy Sell section of a Shareholder Agreement. This important section breaks down the contingency plan in the event a Business Owner passes away prematurely or becomes disabled. In absence of a Buy Sell, upon one of these devastating events, the remaining shareholders may end up having to run the business with the spouse of their deceased or disabled partner. As important as these documents may be, they are not always in place. Even when the documents have been drafted, they should be periodically reviewed and kept up to date. Many times, they are stashed away and as time goes by the business owners may forget how they are structured or become outdated.

A great question to use when opening the conversation with your business owner client could be, “If something happened prematurely to your business partner, what are the contingency plans for your business?” In most cases, clients will not remember what was inserted in the agreement at the time it was written. This is a terrific opportunity to request a copy of the document for review and ensure it still reflects the wishes of the owners.

A properly structured and funded Buy Sell can ensure the family of the deceased receives Fair Market Value for their interest in the business while allowing the surviving owners to continue to run the business with as little disruption as possible. Providing guaranteed capital to fund a Buy Sell using life insurance can be an excellent door opener for you. With the client engaged, it is time to request a copy of the existing Shareholder Agreement, a copy of the Corporate Organizational Chart, and the Fair Market Value of the Company.

It is important to ensure the agreement is up to date and reflects the wishes of each shareholder. In addition, a properly drafted Buy Sell section of a shareholder agreement should mention insurance and suggest the most tax-efficient purchase and sale method based on the corporate structure. Once the Shareholder Agreement, corporate organizational chart, and the FMV of the company are available, the next step is to crash-test the situation and demonstrate the different outcomes.

In our example, let’s assume John and Mike own an Operating business 50/50 which has an FMV of $10M. In this scenario, the Buy Sell section states in event of one of the shareholders early demise the surviving owner would be entitled to purchase the shares off the deceased’s estate. John’s and Mike’s business had strong cash flow and retained earnings. They were not overly concerned with the survivor coming up with the $5M required in order to fund the purchase and sale of the deceased partner's shares. In reality, even though $5M reflects the value of 50% of the business, it is certainly not the true cost of the buyout.

In most cases, without insurance, the interest cost must be added to the total cost, as agreements will have the shares purchased over several years (i.e., 5 or 10 years). As well, the shares are purchased with after-tax dollars and therefore the total cost should be grossed up by the corporate tax rate. And finally, the cost of sales and profit margins should also be taken into consideration. Once profit margins, taxes, and interest costs are factored in, the corporation might need to generate as much as $25M in revenue to net out $5M.

Now that John and Mike understand the impact upon a premature death, not satisfied with the true cost of the transaction, their perspective has changed. Instead of viewing insurance as an expense, they view it as a cost-effective solution.