Buy-Sell Agreements & Your Small Business

It is not lost on small business owners that the value they receive for their business in the event of death, disability, retirement, or sale is as important as ever.

What this planning attempts to accomplish is to avoid surprises or conflicts for business owners and their families. A buy-sell that everyone agrees to and reviews regularly should eliminate the surprises, such as: no funding, dispute as to the sale price, a missed contingency or a sale offer that is less than a desired value.  All of these surprises, and others, lead to headaches, fighting and un-productivity.

A buy-sell agreement is like a pre-nuptial agreement for business owner shareholders or partners.  It is also sometimes referred to as a “business will.”    The agreement is a legally binding contract (either separate from or a part of the partnership or business operating agreement) that controls future ownership of the business. It covers the potential “what-ifs” that could occur.

There are 4 primary forms of buy-sell agreements: (1) an entity (also called repurchase or entity redemption) agreement; (2); a cross-purchase agreement; (3) a wait-and-see (or mixed agreement); and (4) the no-sell buy-sell agreement.

In an entity arrangement, the business entity itself (corporation, LLC, partnership, etc.) is obligated to purchase the owner’s interest in the business if one of the named triggering events occurs. In a cross-purchase arrangement, the surviving owners are responsible for acquiring the interest of a fellow owner who has died, retired, or become disabled.

The wait-and-see approach allows for flexibility in that the surviving owners can delay the selection of an entity or cross-purchase buy-sell plan until one of the triggering events occurs. The no-sell buy-sell is for owners who want the future appreciation of their stock to go to heirs, but not the outright ownership.  Therefore, the agreement passes control of the business to surviving owners, but non-voting interest stays with an heir or heirs.

Some plan must be in place to pay for the obligations created under the agreement.  Typically, insurance is used to create cash at the time of death or disability.  In an entity agreement, the insurance is owned by the business entity and it is the beneficiary.  The face amount (death benefit) of the policy equals the purchase price stipulated in the legal agreement.  In a cross-purchase agreement, the individual owners own policies on one another and use the policy proceeds to purchase the deceased owner’s interest in the business.

Disability income products exist for funding the buyout of an owner who becomes disabled.  One must be familiar with how these function and how they are priced.  DI is as important as life insurance.

Life insurance is crucial too, and if permanent life insurance is used, the cash can provide dollars in the event of retirement or departure via bankruptcy or divorce.  Of course, other investments or cash can be used, but cash-value insurance makes tremendous economic sense.

If you have questions about your business will or buy-sell agreements, Contact Lloyd.

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