Buy-Sell Arrangements
The Need
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For Clients that own businesses, ownership can be one of the most satisfying experiences of their lives. They can follow a dream, earn a good living, provide employment and opportunities for others, and maybe even make a difference in the world. But owning a business also entails a lot of responsibilities—to the company, to employees, and their families.
The Opportunity
For many business owners, their wealth is primarily invested in their business. While this investment strategy can often fuel the growth of the company, it can also present a challenge when it comes to transferring wealth in the case of significant life events. For this reason, having a buy-sell agreement in place is at the root of any successful business succession plan. A buy-sell agreement is a written contract between the owners of a business that establishes rules and expectations around what would happen in the case of a specific triggering event, such as death or disability of an owner. While the agreement itself is a very important first step, it is critical that the agreement also be properly funded.
The death or disability of an owner can have a significant impact on any business. Planning for these types of events is crucial to ensure the continuity of the business and the orderly transfer of an owner’s business interest. While these agreements can be funded in a variety of ways, such as installment payments or borrowing, life and disability insurance are the most common vehicles used in the triggering event of an owner’s death or disability. Life and disability insurance can be used with a buy-sell arrangement to:
Help ensure the continuation of the business in the case of death or disability of an owner
Help ensure the owner’s business interests can be sold at a fair price (known by the owner)
Provide a source of liquid funds to the beneficiaries of the owner.
The Agreement
Who Needs A Buy-Sell Agreement?
The three most common types are
Cross-Purchase — Each owner takes out an insurance policy on the other owner(s)
Entity Purchase — The business takes out an insurance policy on each owner
"Wait-and-See” — A hybrid of cross-purchase and entity purchase
A buy sell agreement can assist in:
Protecting the business by preventing transfers of ownership to unqualified or unwanted persons (e.g., ex-spouses of a divorcing owner or heirs of a deceased owner).
Providing a mechanism for owner(s) to define how their business interest will be transferred as well as the liquidity mechanism for settlement of the agreement.
Usually includes a formula or procedure for determining the sale price.
May establish a funding mechanism to facilitate the purchase of an owner’s interest.
May be used to fix the value of the business for estate tax purposes, subject to IRS requirements.
A buy-sell agreement provides a plan for the orderly transfer of any owner’s business interest. You should consider a buy-sell agreement for your business if: