Buy-Sell Agreements
There are several reasons for business owners to enter into buy-sell agreements
- To create a market for the owner’s business interest at certain triggering events such as death, disability or retirement
- To facilitate a smooth transition of management and control for the surviving or remaining owners
- To provide a mutually-agreeable price and terms (so as to avoid litigation and friction)
- To establish the value of the business for estate tax purposes
- And to provide the family of a deceased owner with liquidity rather than a non-marketable business interest.
A buy-sell agreement can be broken down into three major components
- There are the triggering events that require a business owner to sell (or offer for sale) his or her interest in the business. The most common triggering events are death, disability, retirement or termination of employment, transfers to third parties, and deadlock.
- Purchase price for the business interest- The purchase price may be based on a formula (e.g., book value, multiple of earnings, or fair market value) or may be a fixed amount that is subject to periodic revaluation.
- Payment terms- The agreement should set forth the down payment, the number and amount of any installments, and the interest rate to be used for an installment sale.
Methods of Funding a Buy-Sell Agreement- Guaranteeing sufficient funds with which to purchase the interest of a deceased, disabled or withdrawing business owner is an important part of buy-sell planning. A business has essentially five methods of funding a buy-sell agreement.
- The funds can come from the business’s assets or operating profits. However, most successful business owners do not keep large sums of liquid assets on hand. Instead, they put their money to work in their business.
- A sinking fund can be established. But such a fund may be inadequate if a business owner dies prematurely. In addition, for regular corporations, establishing such a fund may expose the corporation to an accumulated earnings tax problem.
- The business can borrow the funds from a bank. The problem with borrowing, however, is that the loss of a key person might impair the business’s credit-worthiness. In addition, the interest costs may be excessive and the interest expense may not be deductible.
- The business can pay the purchase price on installments. This approach presents the same problems for the business as borrowing from a bank. Moreover, the seller runs the risk that the business may fail and the payments stop.
- And the final method of funding a buy-sell agreement is using life and/or disability insurance- we can help you find the right insurance coverage
Using insurance to fund a Buy-Sell agreement offers the following advantages
- Complete financing is guaranteed from the beginning
- The death proceeds are generally free from federal income taxes
- The policy’s cash value can be used for a buyout due to retirement or disability
- Buying insurance to fund the Buy-Sell agreement may be the most economical method because the premiums paid are usually a fraction of the death benefit (i.e., discounted dollars)
- And the business’s credit position is strengthened.
Please contact us to discuss your situation, and the different types of insurance plans that can be used to fund your Buy-Sell agreement...