Posted: 9-9-24 | Innovia Wealth
You must always plan for the unknown when running a business. Surprisingly, many business owners do not have a buy-sell agreement and/or life insurance. These items, which can ensure a smoother transition of ownership and management of a business in the event of a partner’s death or disability, are critical to an organization. Following is a summary of how it works:
- Purpose – The primary purpose of a buy-sell agreement is to provide a clear plan for what happens to a business if one of the owners (or partners) dies, becomes disabled, or otherwise leaves the business. It helps prevent potential conflicts and ensures business continuity. It is having a plan before the plan is needed.
- Types of Buy-Sell Agreements –
- Cross-Purchase Agreement: Each partner buys a life insurance policy on the other partners. When a partner dies, the surviving partners use the insurance payout to buy the deceased partner’s share of the business.
- Entity-Purchase Agreement: The business buys life insurance policies on each partner. When a partner dies, the business uses the insurance payout to buy the deceased partner’s share.
- Funding – Life insurance is often used to fund buy-sell agreements because it provides a tax-free lump sum payment upon the insured’s death. This helps ensure the remaining partners or the business have the necessary funds to buy out the deceased partner’s share without needing to find the money from other sources.
- Valuation of the Business – The buy-sell agreement should specify how the business will be valued in the event of a sale. This valuation method is critical for setting the price at which the shares will be bought and sold.
- Legal and Tax Considerations – It is essential to consult with legal and tax professionals when setting up a buy-sell agreement. They can help structure the agreement in a way that aligns with tax laws and legal requirements, and ensure it is fair to all parties involved.
- Benefits –
- Business Continuity: Ensures the business continues operating smoothly despite the departure of an owner.
- Financial Security: Provides financial security to the deceased owner’s family by ensuring they receive a fair value for their share.
- Clarity: Prevents disputes among surviving owners or heirs about the value and transfer of the deceased owner’s share.
In essence, a buy-sell agreement funded by life insurance is a strategic tool to protect both the business and its owners, facilitating a smooth transition and maintaining stability during challenging times.
August—The Federal Reserve calms markets again.
Early August began with a big drawdown for stocks and a rally for bonds. The causes were an unwinding of the Japanese Yen carry trade and weak employment data. The Yen carry trade refers to when Japanese Yen savers lend money to global investors at very low rates (e.g., 0.4%), which are then invested in higher yielding assets (e.g., US Treasuries earnings 5.0%). This trade is a risk-averse strategy if the difference between the yen and other currencies is stable. The Yen, however, moved abruptly this month when the Japanese Central Bank (JCB) indicated it would raise interest rates, impacting the exchange rate between the yen and other currencies, forcing traders to unwind their bets rapidly. This caused US stocks to fall 6% and the Japanese market to plunge 12% in one day. The JCB calmed markets quickly by walking back its statement and markets returned to normal in a little over a week. In addition, the unemployment rate increased by 0.5% from its recent bottom, a historical sign of economic weakness. Market participants initially reacted strongly to this data point and sold equities to buy bonds in a flight to safety. Again, this was calmed by Federal Reserve indicating it would cut interest rates on signs of economic weakness. Of course, the Yen carry trade could unravel again, and there are signs of economic weakness like rising unemployment and higher delinquencies in credit card loans (see chart below), but nothing significant enough to make us think a recession is imminent or highly probable.
Credit Card Delinquencies are Rising
September—likely to be volatile
The Federal Reserve is set to cut interest rates for the first time since March 2020, and this tends to be good for both stocks (assuming rates are not cut due to economic weakness) and bonds over the following year. September, though, is the most seasonally negative month for returns (see chart below) and election years tend to exaggerate this predisposition. With this year’s contentious election, we wouldn’t be surprised to see the stock market drop in September and early October and then rally into November and December. Markets dislike nothing so much as uncertainty, and going from more to less uncertainty tends to depress stock prices and vice versa. There are few things more uncertain than how this election will turn out from the President down to local issues. Such periods are good for fixed income returns and one of the many reasons we recommend balanced allocations.
September has historically been the worst month of the year.
We are monitoring the economy, public and private markets, and the geopolitical background carefully. Instead of trying to predict these things with precision, we prefer to set our sails for all types of weather while acknowledging that squalls can happen with little warning. We remain constructive on public market returns, active in seeking higher returns with lower volatility across private market opportunities, and cautiously optimistic that this election and events in Europe, Asia and the Middle East will resolve over time. We like our opportunity set and are excited with several of the managers we have been researching within the private markets. We look forward to updating you on these alternatives over time. Let us know if you have any questions about the above or anything else for that matter.
Private Markets Pulse: Invision Capital Overview
At Innovia, we consistently evaluate private equity opportunities to provide our clients with exceptional investment options. This edition of our Private Markets Pulse focuses on Invision Capital, a prominent player in the lower middle market with a specific emphasis on manufacturing, distribution, and services. Here’s what we have uncovered about Invision Capital and why we think they stand out:
- Strategic Growth Approach: Invision excels in acquiring smaller, established businesses whom have a competitive advantage in their market. The aim is to expand their value before transitioning them to larger private equity firms. Their strategy revolves around purchasing outside of competitive auctions, which allows them to acquire companies at lower valuations. Once these companies have been scaled and optimized, Invision then sells them through auctions where valuations are significantly higher.
- Rigorous Selection Criteria: The firm applies a stringent 11-part criteria to evaluate potential investments, ensuring that at least 9 of these criteria are met before proceeding. This meticulous process is underpinned by a combination of deep-dive analytics and operational acumen, enabling Invision to maximize the performance and value of its portfolio companies.
- Impressive Track Record: The current vintage of their fund is targeting a $600M capital raise and has already completed 6 transactions. Notably, Invision’s track record is impressive. Fund I, launched in 2009, delivered 24% annual net returns, and Fund II, started in 2016, achieved a 35% annual net return.
At Innovia, our comprehensive due diligence process is designed to identify private investment managers and funds that offer not only strong returns but also robust risk management. With a focus on high conviction investments, Invision stands out for its disciplined approach and proven ability to generate substantial growth in the lower middle market. We are committed to providing our clients with opportunities that meet our stringent criteria for performance and risk management.