Keep in mind that to complete your Business Succession Buy-Sell Plan, funds must be available to buy the interests of an owner’s business. In the previous chapter we listed the various means to accomplish this. Let’s now examine one at a time. First we’ll discuss CASH as a method.
Cash can first be made available by accumulating what many financial professionals call a SINKING FUND. In this method, each owner begins by making deposits into a cash balance account that will eventually be used to pay cash for the other owner’s business interests. However, there are problems with this approach. Can you think of any?
In our current environment, interest rates are horribly low. Although the cash is readily available, the return on your investments are so low that it would take a longer amount of time to accumulate the capital needed.. Adding insult to injury, you must pay taxes on any interest earned. You could of course use any number of vehicles to build this SINKING FUND. Nevertheless, all other options are not guaranteed and can and will fluctuate in value. In addition, this method requires strict discipline and often”emergencies” occur making it difficult to maintain this process over a long period of time.
There is another alternative. You, as the buyer, can make a lump sum deposit to buy-out the other owner’s interest. But where will this money come from? Would you need to liquidate an IRA or 401k plan? If so, the full amount would be taxable to you. Even if you had an investment brokerage account you would still have a capital gains tax on all the interest earned. Usually in this type of buy-out, the total lum sum is generally initially not needed. However, if subsequent payments are to be made, there is still the issue with taxes and you may need to redeem the funds when the account is down. Next we will examine some alternatives using CASH.