PROBLEM PRESENTED:
The owners of a fast-growing franchise did not have enough life insurance on themselves to protect their estates and preserve the growing value of their respective business interests in case either one of these key owners passed away.
The business had been structured as a series of separate LLCs, with some entities holding the real estate and the others holding the operating franchises in each market territory. In all, there were 14 LLCs. Together, these LLCs, as an enterprise, would be worth more than any one individual LLC. Yet, in absence of a funded buy-sell agreement between the partners, the LLCs would have to be valued one at a time for far less than the “enterprise value” of all of them combined.
As it stood, if the minority partner died first, his estate would have a difficult time selling a minority interest in these LLCs if the majority owner decided not to buy all or any of them. The majority partner maintained a controlling interest; so a minority interest in several small LLCs would not attract much buyer interest.
If the majority partner died first, the surviving minority partner would simply not have the funds to buy out the interests of the majority partner’s estate, leaving the majority partner’s family exposed to the business risk of losing the major founder’s expertise and leadership. Furthermore, the minority partner had the option, under the LLC Operating Agreements, to cherry pick his purchases among the most profitable LLCs, leaving the majority partner’s estate with far less than the going concern value of the enterprise as a whole.
SEVERAL PROBLEMS SOLVED:
1. Complexity and Cost
With the assistance of our advanced planning team, it was suggested that the owners enter into a Master Buy Sell Agreement applicable to each of the real estate and operating franchise LLCs, which would supersede the provisions of each LLC’s Operating Agreement. Rather than having to purchase 28 separate life insurance policies to cover the values of both partners in the 14 LLCs, only ONE policy each would be required.
2. Establishing the Going Concern Value of the Enterprise
The partners were advised to set up a Buy Sell agreement under which the enterprise value of all the LLCs, current and future, would be determined once a year. Utilizing Blue Sea Advisor’s affordable yet accurate business valuation data base software, a formerly very expensive and complex task was made practical. The value of the total enterprises had to be established before the right amount of life insurance could be secured on each of the partner’s lives.
3. Preserving the Going Concern Value of the Enterprise
The intention of the majority partner was to sell out over the next 5 years. But that could conflict with maximizing the Going Concern Value of the enterprise if the economy were in a recession during this time period. To provide maximum flexibility, the current value of the enterprise would be covered by two 10 year term policies on the partners from one of several top-rated insurance carriers. The future estimated value of the enterprise over the next 5 years could be covered by New York Life’s Yearly Convertible Term policies, one of the most competitive short-term policies on the market.
If growth slowed or reversed, the partners could simply reduce or drop the Yearly Convertible Term policy, while hanging on to the 10-year level term policies to cover the original valuation. But if growth continued at its current blazing clip, the partners would have full coverage of the enterprise value for the entire term of their ownership horizon and would enjoy guaranteed insurability for converting the term or any portion of it for permanent life insurance coverage. The combination of the 10-year term and yearly convertible term policies turned out to be the most cost-efficient strategy for covering the going concern and future anticipated value of the business, as the owners would be neither over-insured nor underinsured.
4. Finding the Best Value in the Marketplace
The insurance professionals at Summit shopped the market for the best combination of premium expense, convertibility, and financial strength ratings, preparing a side-by-side comparison of the top 10 strongest and most competitive term insurance carriers in the country for both partners.
It turned out that one of the partners should go with one carrier and the other partner should go with a different carrier for the best overall premium rates. Both carriers met our strict financial strength thresholds. Premium budgets were prepared based on conservative, mid-point, and optimistic growth projections.
By combining New York Life’s competitive Yearly Convertible Term policies (for the future growth value of the enterprise) with the two most competitive 10 year level term carriers (for the existing value of the Enterprise), the business owners received an ideally-priced combination of policies to achieve their aims, keeping the total cost of insuring the current and future expected values of their enterprise to under .0075 of projected EBITDA over the next 5 years–a small cost in relation to the protection each owner would receive.