Buy-Sell Agreements are important to business succession planning for many business owners. When might you consider a buy-sell agreement as part of your estate and business succession planning?
If you own a portion, but not all, of the business, your partners probably do not want to be “in business” with your spouse or children upon your death. Having a buy-sell agreement could help with a smooth transition of management and control of the business if one partner dies. Funding the buy-sell agreement with life insurance provides a source of funds to purchase your share of the business from your estate or family members. It provides business continuity. The agreement can also help establish the value of the business in advance to reduce disputes and the potential for litigation.
Absent a buy-sell agreement, the business may suffer from loss of working capital in the event of death of an owner. The business may not have cash or credit available to purchase the deceased owner’s share of the business. The business might be gridlocked with no one with clear authority to make or act on business decisions.
Two types of buy-sell agreements useful in business succession planning are the cross purchase agreement and the entity purchase agreement.
In a cross purchase agreement, the business owners enter into a buy-sell agreement stating that the survivors agree to purchase the business share of the deceased owner. In order to provide a source of funds for the purchase, the owners could each purchase life insurance policies on the lives of the other owners. The deceased owner’s share would be purchased with the proceeds from the life insurance policies. The surviving business owners would then own the entire business, and the deceased owner’s estate or heirs would have the funds from the life insurance to compensate them for the deceased owner’s share.
An entity purchase agreement, on the other hand, states that if one owner dies, the business itself will purchase the deceased owner’s interest in the business. In such a case, the business entity might purchase life insurance on each of the owners lives in order to fund the buyout.
There are advantages and disadvantages to each type of buy-sell agreement. Factors that might come into play in making a choice for your situation include the number of owners, the relative age and health of the owners, the type of entity involved and tax considerations, and the financial and credit position of the business.
For assistance in developing your buy-sell agreement and overall business succession planning, contact Hindson & Melton LLC.
Karen S. Hindson – June 27, 2012