The value of your investment in your brewery comes to more than the sum your physical assets. Beyond equipment and buildings and computers and cash, your value lies in the equity you have built and will build over the years. That’s your greatest asset, and as such, deserves as much protection as those hard assets.
Protection planning done properly is the process of ensuring your equity interest is safe from other owners, creditors, plaintiffs, and others. It means that your interest will remain protected as you grow your brewery business. And it ensures you will be able to pass the value of your interest along to your heirs as you wish and in the most tax-efficient manner.
Protection planning is unique to each situation, to each business owner, but typically includes some common attributes, processes and agreements:
- Shareholder/member/partner agreements
- Buy-sell agreements
- Succession and estate planning
- Reviewing and assessing life insurance needs
- Evaluating existing life insurance policies
- Key-person planning
Protection planning is particularly important for businesses with more than one owner, whether or not they are related. And the bigger the business, the more vital protection becomes. We live in a litigious society and failing to protect your business from a potential lawsuit, whatever the reason, could be disastrous. Agreements among partners and family members and advanced succession planning not only clarify expectations among interested parties, including equity partners, but are key to avoiding disagreements that can ruin a business and destroy a legacy.
Life insurance and buy-sell agreements
A life insurance policy is a useful tool for protecting your value in your business for many reasons, including:
- Policy premiums are often low compared to the death benefit, especially for younger, healthier owners.
- Death benefits paid to beneficiaries are income tax-free.
Life insurance is commonly used in buy-sell agreements, which are designed to govern the transfer of ownership in the event of an owner’s death, disability, or other exit from the business, including voluntary retirement. There are three types of buy-sell agreements:
- Redemption agreement: In a redemption agreement, the owner agrees to sell their interest back to the business according to the price, terms, and circumstances set in the agreement. In the case of the insured owner’s death, the estate of the deceased owner sells that owner’s interest back to the business. The purchase is financed by a life insurance policy owned by the business on the owner’s life. The business uses the tax-free death benefit to buy the deceased owner’s interest. This type of agreement is often used to provide a way for a surviving spouse or children to receive fair value for the deceased owner’s interest and to provide the business with a mechanism to buy out the surviving spouse or heirs without undue financial hardship.
- Cross-purchase agreement: The owners of a business agree to offer their interests for sale to the other owners at a designated price and terms. The agreement typically requires the estate of the deceased to sell the individual’s interest to the other owners according to those terms, and the other owners may be obligated to buy the interest or sell to a third party. Again, the owners will use life insurance, which they will hold on each other, to finance their purchase with the tax-free death benefit.
- Hybrid agreement: Here, the owners agree to offer their ownership interest for sale to the entity or the other owners, or a combination of the two. A typical agreement might offer the ownership back to the business first, then to the other owners if the entity does not purchase it. Or if the other owners decline, the contract might require the business to buy back the deceased owner’s interest.
Buy-sell agreements are not as cut and dried as their terms. A variety of issues must be considered and decided upon, including:
- Defining what happens at death, disability, or other withdrawal of an owner
- Identifying those individuals to whom ownership can be transferred
- Restricting ownership transfer requirements by sale, gift, owner bankruptcy, divorce, or death
- Whether and how to allow gifting and transfers to family members and transfers to other shareholders
- Valuing the business to determine a purchase price
- Payment provisions
- Funding: life insurance or limits on entity-level borrowing in the absence of life insurance for a redemption agreement
- Assignment of management decisions before and after the transfer
- Issues specific to S-corporations
Businesses use key-person planning to attract and retain key employees as well as provide protections for the company in the case of the death or disability of a key person. Can the business continue to operate without the individual? How long will it take and what would be the cost of replacing that individual? Beyond a key-person life insurance policy, planning can include providing employer-sponsored health insurance and retirement plans and group life insurance.
Types of key-person planning include:
- Life insurance or disability insurance: The business pays the premiums and the company is the beneficiary and uses the proceeds to replace the lost employee.
- Compensation planning: The employee is rewarded for their work through bonus, deferred compensation, and equity plans, and the business benefits by being able to attract and retain key talent and incentivize employees to perform at their highest levels.
As critical to a business as protection planning is, it is also complex. It requires the support of a knowledgeable financial advisor who can not only provide direction on what type of planning best suits your brewery and ownership structure, but ensure the plans and agreements you implement are designed properly and will perform as intended when they are needed.