Buy - Sell Agreement

A typical small business owner spends so much time attending to immediate tasks that planning for the future is often neglected.  This is too bad, because business owners who neglect planning now may cause their families and business partners to pay dearly for this oversight later.

If you're a business owner, you may not have planned sufficiently for the future if a buy-sell agreement hasn't been drawn.  A buy-sell agreement decrees how a business, or share of a business, will be transferred upon death, disability or retirement.  A buy-sell agreement can be between partners, between a business entity and its stockholders, or between an owner and a key employee.  It predetermines who will receive a business or its share, how the sale or transfer will be funded and it provides a means for paying personal estate taxes after the transfer.

There are three types of buy-sell agreements and all determine the value of the business through an updated business valuation or a formula derived from an older valuation.  The first is a stock redemption plan, which is an agreement between a corporation and its shareholders.  A second type is a cross-purchase plan, which is an agreement usually among shareholders or partners.  A third, less known option is a "wait-and-see" buy-sell plan, offers flexibility and tax and economic advantages that take the best from the first two options.  In this buy-sell scenario, a corporation can exercise its buy option or waive its right, thus triggering the cross-purchase option to kick in.

Regardless of which buy-sell plan is chosen, business owners should consult with a professional to help avoid tricky tax and procedural pitfalls.  And, equally important, a financial professional can present appropriate funding options.  Without them, all the planning in the world can be for naught. 

When a business owner is disabled or opts out of the business for other reasons, other owners get first crack at that share of the business.  Of course, they need the money to acquire those shares.  When a business or its shares become available because of the death of an owner or shareholder, surviving owners again get the first option to buy, even though the business interest is usually willed to a family estate.  Most buy-sell plans include the stipulation that surviving family members, if not previously involved in the day-to-day business operations, sell their interest to surviving owners.  The cash received for this interest helps to meet family estate tax obligations and the business is in the hands of people best qualified to run it.

Self-funding, borrowing and insuring a buy-out are the three basic ways most buy-sell plans are funded.

With self-funding, surviving owners or shareholders can either pay for the business interest outright or through an installment plan.  Buy-out funds can also be accumulated through the establishment of a sinking fund, basically a savings plan in which business owners put aside money on a regular basis for the sole purpose of buying shares when they become available.  While this funding arrangement helps money accumulate in the future, all the while earning interest, borrowing provides the money upfront with interest payments figured into future payments.  All three arrangements have a variety of holes should the unexpected happen.

What if death or disability occurs before funds have accumulated to meet the buying price?  What if borrowing becomes tight because the departure has an adverse affect on business?  Can a deceased owner's estate afford to wait for an installment plan?

That's where insurance comes in.  Bought by either the company or by partners on each other's lives, insurance is a method of providing cash when it's needed.  Through a variety of insurance programs such as split-dollar, in which an insured owner and other partners split the cost, tax-advantaged savings can be accomplished now while future payout is guaranteed*.  Whole life insurance, which builds cash value, can also provide needed funds when events other than death trigger a buy-out clause**. And many companies now sell disability insurance to specifically meet buy-sell needs.

The existence of a buy-sell plan ensures the orderly transition of a business, and a proper funding vehicle ensures the money will be there when the time comes. Plan for the future now.  Your business depends on it.

 

*Guarantees are dependent on the claims-paying ability of the issuing company.

 

**Policy loans and withdrawals may reduce the policy’s cash value and death benefit and may results in a taxable event.

 

This information is not intended as tax or legal advice.  Please consult with your Attorney or Accountant prior to acting upon any of the information contained in this article.

 

TC75386(0813)P