If you are a owner or part owner of any business, one of your primary concerns is to ensure the continuity of the business should you or one of your partners dies. With a buy-sell agreement one party is obligated to purchase a deceased business owner’s interest in the business at a certain pre-determined price, and another party – the deceased owner’s estate or their heirs – is obligated to sell the interest at that pre-arranged price. By establishing a buy-sell agreement, you can help ensure a smooth transition of ownership between the parties, with minimal disruption to the day-to-day activities of the business.
An effective buy-sell agreement must establish:
• Who will purchase the decedent’s share of the business
• What price the decedent’s heirs or estate will sell the share to the other party
• When the sale of the business will take place and how it will be funded.
There are two types of buy-sell agreements, both utilizing life insurance. Under both types of arrangements, the total amount of insurance should approximate the anticipated purchase price of the insured’s share of the business.
In a Cross-Purchase Buy-Sell Plan each business owner purchases a life insurance policy covering the life of every other owner. Each business owner pays the premiums and is the beneficiary of the policies that he/she is purchasing. If an owner dies, the surviving owners use the life insurance death benefit to purchase the deceased owner’s interest.
In an Entity/Stock Redemption Buy-Sell Plan the business purchases life insurance policies on each owner. The business pays the policy premiums and is the beneficiary on each policy. If one of the owner’s dies, the death benefit from his/her policy is paid to the business to purchase that owner’s interest in the company.
The buy-sell agreement can prevent an owner from selling his interests to an outsider without the consent of the other owners. The agreement usually takes one of three forms:
Cross-Purchase Agreement -- In this form, a withdrawing owner agrees to sell his interest to the remaining owners. This is the simplest form of the buy-sell agreement. It is suitable especially for the small business with only a few owners. As the number of owners increase, this form can become unwieldy. In a larger business, an entity-purchase agreement may be more suitable.
Entity-Purchase Agreement -- In this form of the buy-sell agreement, the withdrawing owner agrees to sell his interest to the entity, which then retires the ownership interest.
Hybrid Agreement -- This form is a combination of the first two. Typically, the withdrawing owner must first offer his ownership interest to the entity. If the entity declines or is unable to make the purchase, then the shares must be offered to the other owners.Every co-owned business needs a buy-sell, or buyout, agreement the moment the business is formed or as soon after that as possible. Every day that value is added to the business without a plan for future transition, it increases its financial risk.
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