Buy/Sell Agreement

Overview

The uniqueness of a business relationship between partners or a closely held company is a powerful enterprise. Ideally your business partner is one of your business' greatest assets. Unfortunately, that person can also become your greatest potential liability. Ask yourself a few key questions:

What if my partner died?

What would happen to the business?

What would happen to my family and my partner's family?

There are 4 options to choose from:

Four Basic Choices

1. You could liquidate the business and distribute the remaining assets. Of course, in the process, you would do away with your own source of income, as well as with a business enterprise in which you've invested a great deal of time and money. Plus, the business assets might only sell for a fraction of what they are worth.
2. You could take in your late partner's heirs as your new associates. However, keep in mind that a successful partnership is a delicately balanced relationship. Except in rare situations, bringing on board a deceased partner's spouse or other heir can be difficult.
3. You could sell out to the heirs. This also rarely works. Starting with an almost inevitable tug-of-war over the purchase price, the situation usually goes downhill from there.
4. You (and other partners) could buy out the surviving heirs' share of the business. This, in most cases, is the most practical course of action. Once again, however, there are the problems of establishing price and terms, as well as coming up with the money.

The ideal solution most often is one that                             

Gives control of the business to the surviving active owners while providing fairly and adequately for the deceased's family members.

It is a solution that does not impose a financial burden on the business and provides a fair, objective means to value the deceased partner's share of the business. Most importantly, it prevents legal hassles and feelings of bad faith and can allow friendship to continue.

The Buy-Sell Concept                                                      

A Buy / Sell Agreement is a legal document, prepared by an attorney, that is designed to provide for a smooth succession of your business upon the occurrence of a specified event (such as death, disability or retirement). The agreement spells out the terms under which a designated co-owner, employee, heir and/or other party will buy your interest in the business if you die, retire or become disabled. In addition the agreements normally include the actual purchase price or provides a formula for determining the price. The purpose of this is to assure that the business continues and your dependents receive the fair market price for your interest in the business.

Funding Options

The agreements also need to stipulate how they are to be funded.   There are several funding options, sinking funds, loans, installments  and life insurance.   Insurance on the owner is one of the most popular, since it helps assure that dependents will receive the full purchase price in cash.

The Advantage of the Life Insurance

The advantages of cash value life insurance as a buy-sell funding vehicle include:

• Proceeds are delivered at the exact moment they are needed most, providing necessary cash to fund the agreement
• Under most circumstances, proceeds are received by the beneficiary income tax free.
• The cost can be minimal compared to other methods. The policy owner buys future funds with discounted dollars in the form of scheduled premium payments.
• Cash values accrue within the policy on a tax-advantaged basis. Should all parties live to retirement, these cash values can be used for a buy-out or to supplement other retirement income.

Other Related Articles on this Site 

Who Needs Life Insurance and How Much is Enough
Life Insurance for Estate Protection Business Continuation Planning

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Biz Owner / Executive Compensation Using an Executive Bonus Plan
Biz Owner / Executive Compensation Using a Deferred Compensation Plan
Buy / Sell Agreement
Key Person Coverage
Executive / Biz Owner Compensation using Split Dollar Strategy
Keeping Your Business in the Family
Bringing Children into the Family Business 

What is a Fixed Annuity
What is a Variable Annuity 

Section 125 Cafeteria Plan

Retirement Plan Comparisons
How to Arrange a 401K Rollover

Content is for informational purposes only and may not accurately reflect your specific situation. Information is not intended to provide legal, tax, or accounting advice. You should consult a qualified advisor for advice specific to your own circumstances.