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Learn more about Buy-Sell Agreements

There are 2 basic forms of Buy-Sell Agreements

1. Cross purchase agreement.

Under a cross purchase agreement, the owners of the business enter into the buy-sell agreement among themselves obligating each other.

For example, Frank & Joe are equal shareholders of X Inc. Under the cross purchase agreement Frank and Joe each agree to buy the other's half of the business in the event of the other's death, disability or retirement. To fund the agreement, each buys a cash value life insurance policy on the life of the other.
The cross purchase agreement is very popular with companies having few owners. The surviving owners benefit from an increase in their cost basis when the purchase is ultimately made. The cross purchase agreement becomes more difficult to fund when their are more than two owners.

For example, if Frank and Joe were joined by Tom a total of six life insurance policies would be required. Also, the premiums on the policy may vary based on the ages and health of the owners.

2. Entity purchase agreement (also called a redemption agreement)

The owners of the business contract with the company itself. The company is then obligated to buy the share of the owner who has died, retired or become disabled. If the agreement is funded, the policies are owned by the company. Redemption agreements can be structured to take advantage of special estate tax rules (Sec. 303) and they may reduce the number of policies required.

By utilizing some form of a Buy-Sell Agreement, the small business owner insures the continuance of the business he/she has worked so hard to create. This makes life much easier for the remaining partner(s) in the business as well as the family members.

More advantages of a Buy-Sell Agreement

  • Avoids the need to sell the business at an unfairly low price
  • Avoids potential conflicts of interest between surviving owners (if any) and the heirs or beneficiaries
  • Can establish the value of the business for estate tax purposes if structured properly
  • Maintains stability of business operations
  • Can improve the creditworthiness of the business
  • Maintains the legal status of your S-corporation, partnership or professional corporation

 

What happens when an owner dies?

 

Sole proprietor

The business enterprise terminates. A personal representative can continue the business but is not allowed to benefit from the activities needed to continue the business.

Partnership

The partnership dissolves. The partnership may wind down and liquidate or the surviving partners may continue the business as a new partnership

Professional Corporation

Many states limit ownership to members of the same profession meaning heirs or a personal rep could not assume ownership

Corporation

The business does not terminate, but is typically disrupted by the loss.

 

How do you implement a Buy-Sell Agreement? If your business or partnership is complex setting up a Buy-Sell Agreement can be very complex as well, because it will involve tax and legal issues that could impact you and the company.

  • It is prudent to seek help from a tax advisor, attorney and financial advisor as appropriate.
  • Decide what type of buy-sell works best for you.
  • Execute the Buy-Sell Agreement by having all parties sign including spouses
  • Periodically review the Buy-Sell Agreement

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