03 Mar Your Succession Plan Has a Funding Problem You Haven’t Solved

Let me tell you about a business owner I’ll call Richard. He had a beautifully drafted buy-sell agreement. Detailed triggering events. Professional appraisal requirements. Carefully negotiated terms. On paper, it was everything an attorney could ask for.

Then his partner died.

And Richard discovered that the life insurance policies they’d purchased fifteen years earlier, when the business was worth $6 million, had never been updated. The business was now worth $18 million. The insurance covered a third of the buyout obligation. Richard had a $12 million gap with no plan to fill it.

A buy-sell agreement without adequate funding is a promise you can’t keep. And a promise you can’t keep is worse than no promise at all . . . because it creates expectations that will turn into resentment, litigation, or both.

The Four Ways to Pay for a Buyout

There are really only four ways to fund a purchase obligation under a buy-sell agreement: savings, life insurance, third-party debt, and installment payments over time. Each has advantages. Each has limitations. And most succession plans lean too heavily on one while ignoring the others.

Life Insurance: Powerful but Not Permanent

Life insurance is the cleanest solution for death-triggered buyouts. The owner dies, the policy pays, the buyout is funded in a lump sum. Simple.

Except that policies need to be maintained. Premiums need to be paid. Coverage needs to match the current value of the business . . . not the value from when the policy was purchased. And the ownership structure of the policies needs to match the structure of the buy-sell agreement.

I’ve seen situations where the company owned the insurance but the buy-sell called for a cross-purchase between individual owners. The result: the company received the insurance proceeds, but the individual owners had the obligation to buy. The cash was in the wrong hands. That mismatch turned a straightforward transition into a six-figure legal battle.

Life insurance also doesn’t help with lifetime triggering events like disability, retirement, and voluntary departure. For those, you need other funding mechanisms.

Savings and Sinking Funds: Good in Theory

Setting aside money over time to fund future buyout obligations sounds prudent. And it is . . .  if you can actually do it.

The challenge is that savings must come from after-tax dollars. In a 35% tax bracket, it takes roughly $154 of income to save $100. Over years, that adds up. For a business worth $10 million with multiple owners, the savings required to fund potential buyouts can be staggering.

Most businesses never accumulate enough. Cash gets reinvested. Opportunities arise. The sinking fund is always the first thing to get raided when cash is tight.

Debt: Borrowed Time at a Cost

Borrowing to fund a buyout is possible but dangerous. The debt has to be repaid (again, with after-tax dollars) plus interest. The payments can strain the very business that’s generating the income to make them.

I’ve watched businesses take on buyout debt that consumed so much cash flow that they couldn’t invest in growth, couldn’t weather a downturn, and ultimately couldn’t survive. The owner being bought out got paid. The business that funded the payment didn’t make it.

Installment Payments: The Default That Can Crush You

When all else fails . . . when the insurance is insufficient, the savings aren’t there, and the debt is too risky . . . the buyout gets paid in installments. A promissory note. Monthly or quarterly payments over five, seven, even ten years.

This is the default mechanism in most buy-sell agreements, and it’s the one most likely to create conflict. The selling owner or their family wants to be paid quickly. The buying owner or the company wants manageable payments. If the payments are too high, they can bankrupt the business. If they’re stretched too thin, the selling family waits years for money they need now.

The key is structuring installment terms before a triggering event . . . when everyone is thinking clearly and negotiating in good faith. After someone has died or become disabled, the conversation gets a lot harder.

The Real Problem: Nobody Reviews the Funding

The most common failure isn’t choosing the wrong funding mechanism. It’s never revisiting the funding at all. Business values change. Insurance policies lapse. Partners age and become uninsurable. The agreement that was perfectly funded in 2018 is woefully underfunded in 2026.

A succession plan should be reviewed every two to three years and whenever there’s a significant change in the business. New partners. Major growth. Changes in ownership structure. Each of these events should trigger a review of whether the funding matches the obligation.

Because a succession plan is only as good as your ability to pay for it.

Is Your Business Protected?

At Garza Business & Estate Law, we work with a select group of business owners each year to help them protect what they’ve built: their businesses, their wealth, and their legacy. We are selective in choosing our clientele because the work we do requires focus, depth, and a level of attention that simply isn’t possible when you’re trying to serve everyone.

If what you’ve read here resonates with you . . . 

If you recognize pieces of your own situation in these stories . . . 

Then you may be exactly the kind of business owner we’re built to help.

Apply to work with us here: https://lgarzalaw.com/schedule-online/