Risk to equity owned

Q: How often should a buy-sell agreement and funding be reviewed?

At least once a year with a qualified professional. Reviews confirm that: The valuation method is clear and current Funding reflects updated business valuation Insurance policies align with today’s risks

Q: What is the simplest way to explain buy-sell arrangements to clients?

A buy-sell arrangement is like a safety net : The legal agreement decides the rules of the game (who buys, at what value, under what conditions). The funding ensures there’s actual liquid cash available when the terms of the agreement are triggered.

✨ In summary

Risk to equity owned refers to the likelihood that the owner’s equity will fail to convert into fair, liquid value in the event of death, disability or dispute.

Risk to equity owned is based on whether the owner has an up-to-date buy-sell agreement with a proper funding mechanism.

How RISR estimates risk to equity owned

RISR measures risk to equity owned based on whether a buy-sell agreement is in place, if it is funded, and when the last time it reviewed by a professional was.

To measure this, RISR asks business owner clients two questions:

Do you have a buy-sell agreement and funding in place?
If so, when was it last reviewed?

The following table shows how answers to this question inform risk to equity owned.

Estimating risk to equity owned

Risk Level	Contributing factors
🔴 High	Buy-sell agreement and funding are not in place or have not been professionally reviewed for more than 3 years.
🟡 Moderate	Buy-sell agreement and funding are in place and have not been reviewed for 1 to 3 years.
🟢 Low	Buy-sell agreement and funding are in place and have been professionally reviewed within the last year

This approach assumes that regular professional reviews of the buy-sell agreement and funding will help ensure they are viable and effective.

Owners need a comprehensive approach to risk management

Clients that own businesses have a unique set of risks that are important for advisors to consider and help mitigate during financial planning.

Risks that business owners and their advisors need to keep in mind:

Wealth concentration risks. Most owners have a high concentration of wealth in the business. Advisors can work with owners to find ways to diversify their portfolio by allocating compensation from the business to savings and other investments assets.
Business risks: The likelihood of disruptions to operations or negative impacts to revenue or profitability based on the characteristics of the business. he risk profile of the business is a key driver of the value of the business today, the potential value in the future, and the stability of the owner's income.
Risk to equity owned: In addition to risks within the business itself, the current value of the owner's equity may be at risk in the event of death, disability, or dispute if they do not have a proper buy-sell agreement and funding mechanism in place.

The importance of a buy-sell agreement and funding

Owner's dedicate their lives to building their business. An updated buy-sell agreement and funding mechanism protects this value.

Showing clients the benefits of a buy-sell arrangement:

Protects the value the client has built
Protects the longevity and continuity of the business
May open opportunities to optimize estate taxes

Show clients how buy-sell arrangements work in simple terms

Before diving into the detail of comparing buy-sell structures or discussing funding mechanisms, advisors should start by explaining the importance of buy-sell arrangements and explaining how they work in simple terms.

Buy-sell arrangements consist of the following two components.

A legal agreement. A legally binding contract among business owners is required to govern how equity is valued and what happens to your equity in the event of death, disability, retirement, or voluntary exit.
A funding mechanism or insurance policy. In order to be viable when triggered, buy-sell agreements must be backed by funding. Common vehicles include life insurance, disability insurance, or cash reserves.

Reviewing and updating buy-sell arrangements

Measuring risk to equity owned based on how recent the buy-sell arrangement was reviewed assumes that professional reviews will help ensure the agreement and funding are viable and effective.

These reviews should be done at least annually to confirm that:

Valuation methodology is clearly listed in the agreement typically via an attached Schedule A
Funding levels are reflect recent business valuation estimates
Insurance policies cover unforeseen events

Frequently asked questions

What does “risk to equity owned” mean?

Risk to equity owned refers to the likelihood that the client's ownership stake in the business will fail to convert into fair, liquid value in the event of death, disability, or dispute.

How does RISR measure risk to equity owned?

RISR looks at three main factors:

Whether a buy-sell agreement is in place
Whether the agreement has a funding mechanism (e.g., insurance or cash reserves)
When the agreement and funding were last professionally reviewed

How often should a buy-sell agreement and funding be reviewed?

At least once a year with a qualified professional. Reviews confirm that:

The valuation method is clear and current
Funding reflects updated business valuation
Insurance policies align with today’s risks

What is the simplest way to explain buy-sell arrangements to clients?

A buy-sell arrangement is like a safety net:

The legal agreement decides the rules of the game (who buys, at what value, under what conditions).
The funding ensures there’s actual liquid cash available when the terms of the agreement are triggered.

Learn how to provide deeper financial planning to business owners