Probably the main piece in a Business Continuation Plan, is a Buy-Sell Agreement, which is one of the most efficient means of transferring a business interest after a potentially disruptive event such as an owner’s retirement, incapacity or death.
A Buy-Sell Agreement could be the solution to the sudden death of a business owner or partner, a situation that could bring uncertainties to the life of a business. A Buy-Sell Agreement can help protect the owners of a business from the effects of unintended and unwelcome transfers of ownership. It can also protect the heirs of the owners by giving them (the heirs) the opportunity to turn their shares of ownership in the business, into cash. It is also important to develop a plan that helps fund the transfer of ownership of the business, or of part of the business.
What Is A Buy-Sell Agreement?
A Buy-Sell Agreement is one of the most efficient means of transferring your business interest. It is primarily used to make sure that there is a smooth continuation of a business after a potentially disruptive event, such as an owner’s retirement, incapacity or death. A buy-sell agreement is a valuable estate planning tool than can provide for the orderly succession of a family business and also the liquidity needed for payment of a deceased owner’s estate settlement costs and taxes. Further, a Buy-Sell Agreement can establish the purchase price as the taxable value of an owner’s business interest, avoiding unexpected estate tax consequences at the time of the owner’s death.
Types Of Buy-Sell Agreements (multiple owners)
Entity-Purchase. The entity (the business) purchases one life policy per owner for funding. When one of the owners dies, the entity collects on the life policy and pays the new owner of the interest correponding to the deceased owner pursuant to the previously created Buy-Sell Agreement.
- It is simple to create as only one policy needs to be purchased for each owner. The more owners, the more this approach makes sense, if simplicity is an objective. However, there are potential tax disadvantages that may be important to the owners.
- The business purchases life insurance on the lives of each of the owners and is the owner, beneficiary and premium payer on the policies.
- The amount of coverage on each owner is the value of the individual’s ownership in the business.
- Upon the death of an owner, death benefit proceeds are paid to the business.
- The death benefit proceeds are used to buy the deceased owner’s interest in the business from the deceased’s heirs or estate.
Cross-Purchase. Each owner must purchase/own a life insurance policy of the life of each of the other owners to fund the purchase of that owner’s share.
- Each individual owner agrees to purchase each others’ interest in the business upon the other’s death and plan to use life insurance proceeds to fund the purchase.
- Each owner purchases a separate life insurance policy on each of the other owners. The total amount of coverage on each owner is the value of the individual’s ownership in the business.
- Upon the death of an owner, life insurance proceeds are paid to each surviving owner.
- The surviving owners use the death benefit proceeds to purchase the deceased owner’s share of the business.
One-Way Buy-Sell Agreement (single owner)
The death of a single business owner, regardless of the form of entity, could mean the death of the business. To close a proprietorship at the death of a single owner, the executor must bring the business to a conclusion. The business may have to be sold at a discount in a forced liquidation. Employees may lose their jobs and the sole propritorship’s family may be left with no income. Vendors , banks and other creditors may want to be paid off. Receivables may be difficult to collect.
A One-Way Buy-Sell Agreement may be the solution. If a potential purchaser can be identified, possibly from among family members, valued employees, or even a friendly competitor, a simplified form of buy-sell agreement, called One-Way Buy-Sell Agreement, could be used to facilitate that transfer of the business interest.
The purchaser typically will acquire a life insurance policy on the life of the owner in an amount sufficient to meet the payment obligations under the agreement. The purchaser would be the owner and beneficiary of the policy and would likely be required by the agreement to maintain the policy through premium payments and to notify the owner prior to exercising any policy rights that might affect its value. If the purchaser is also obligated to purchase the business if the owner becomes disabled, the purchaser often will want to insure this obligation as well.
Tax Treatment of Buy-Sell Agreements
To evaluate the tax consequences to the owner(s) of implementing a Buy-Sell Agreement, and which type, the owner(s) should contact his/her tax advisor or attorney.
Funding a Buy-Sell Agreement
In conjunction with a Buy-Sell Agreement, the owner(s) need to have a funding plan in place. Otherwise, the buyer(s) may be forced to sell assets, take out loans, etc. There are several ways to fund a Buy-Sell Agreement and several factors that may influence the choice of funding method. Funding methods could include; Cash; Borrowing; Installment Sale; Self-canceling installment note; Sale Leaseback; Deferred Compensation; Life Insurance; Disability Insurance. Insurance is generally the most cost-efficient way to fund a Buy-Sell Agreement. It is the funding element that makes carrying out the requirements of the agreement possible by providing the necessary funds just when they are needed. It obligates the money for the stated purpose, thus assuring that the terms of the agreement will be implemented.
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More About Buy-Sell Agreements
A Buy-Sell Agreement is a legal document and, consequently, needs to be prepared by your attorney and reviewed by him/her on your behalf. Insurance agents are not authorized to prepared documents on behalf of clients or prospects. The Buy-Sell Agreement establishes under what conditions, to whom and at what price an owner, partner or shareholder can or must sell his or her interest in a business.For more details as to who may need a buy-sell agreement and the benefits it may bring to business owners, click on the link below:
Should You Get A Buy-Sell Agreement?
Contact us for assistance with questions as to whether a Buy-Sell Agreement is something that you should have, given the specifics of your business and your personal situation:
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