Overview

Main Menu Name: Buyout

The program performs an analysis of funds needed to buy out a business. It calculates the profit needed to pay principal, the sales needed to provide buyout funds, and the net advantage of life insurance.

In this article:

• Background
• Why should I use this calculator?
• Getting Started
• Entering Data
• Results

Background

The program calculates the cost of an installment purchase as an alternative to funding a buy-sell agreement with life insurance. It shows the total premium outlay to fully fund the buy-sell compared with the profits needed if there is no insurance. This assumes that the business or the surviving shareholders buy out a decedent's stock over a period of years in the form of installment payments. It shows the gross amount of sales necessary, at the firm's profit margin, to equal the after-tax profits to pay each installment plus interest.

There are many drawbacks to the installment method of paying for a deceased co-owner's business interest:

• The installment method may not provide the large amounts of cash needed by the client's family to pay federal and state death taxes and other estate settlement costs.
• The financial security of the decedent's family remains tied to the business.
• The cost will be incredibly high, even if interest on the unpaid balance is deductible (it probably will not be in some cases).

It is essential that a client understand the true cost of a non-insured buy-out. For example, assume the purchase of a $1,000,000 business interest including ten annual principal payments of $100,000 a year, plus interest on the unpaid balance at 10 percent. If the business buys the decedent's stock, is in a 34 percent tax bracket, and enjoys a 20 percent profit margin, the business will have to earn $2,065,150 in profits and $10,325,750 in sales!

Why should I use this calculator?

• To analyze and illustrate for your client the advantage of life insurance as a funding mechanism for a buy-sell agreement.
• To test and show a client the true overall cost of using the installment method for purchasing a business interest.

Getting Started

The program calculates the cost of an installment purchase as an alternative to funding a buy-sell agreement with life insurance. It shows the total premium outlay to fully fund the buy-sell compared with the profits needed if there is no insurance. This assumes that the business or the surviving shareholders buy out a decedent's stock over a period of years in the form of installment payments. It shows the gross amount of sales necessary, at the firm's profit margin, to equal the after-tax profits to pay each installment plus interest.

There are many drawbacks to the installment method of paying for a deceased co-owner's business interest:

• The installment method may not provide the large amounts of cash needed by the client's family to pay federal and state death taxes and other estate settlement costs.
• The financial security of the decedent's family remains tied to the business.
• The cost will be incredibly high, even if interest on the unpaid balance is deductible (it probably will not be in some cases).

It is essential that a client understand the true cost of a non-insured buy-out. For example, assume the purchase of a $1,000,000 business interest including ten annual principal payments of $100,000 a year, plus interest on the unpaid balance at 10 percent. If the business buys the decedent's stock, is in a 34 percent tax bracket, and enjoys a 20 percent profit margin, the business will have to earn $2,065,150 in profits and $10,325,750 in sales!

Entering Data

1. Purchase Price:  Enter the purchase price of the business.
2. Number of Annual Installments:  Enter the number of annual installments
3. Interest Rate on Unpaid Balance:  Enter the interest rate paid on the balance.
4. Purchaser's Income Tax Bracket:  Enter the purchaser's income tax bracket.
5. Profit Margin of Business:  Enter the profit margin of the business (assuming the business will be the buyer). This is the net income the business places into surplus for every dollar in sales. Most businesses do well to net $.10 to $.15 on a dollar of sales.
6. Total Life Insurance Premiums:  Enter the total amount of life insurance premiums over the selected period of time.
7. Is Interest Cost Deductible?:  Select whether the interest expense is tax deductible or not.

Results

The program calculates the average unpaid balance, the average annual interest payment, and the profit needed to pay each annual installment. It also calculates the average annual profit needed to pay the entire year's installment payment including interest and principal, the total profits needed to provide buyout funds, and the sales needed to generate buyout funds.