If you got hit by a bus tomorrow, what would happen to your business? Would your spouse all of a sudden be thrust into the role of owner/operator of your business? And, how do you think your partners would feel about that?
The need for a contingency plan to deal with the unexpected death of a business owner becomes very apparent when these questions are asked. And, if your business doesn’t have a plan, the consequences to your business and your family may be irreversible. The business may suffer a loss of revenue and customers. Internal conflicts may arise among the remaining management and ownership team, especially if there’s a new owner who is unfamiliar with the business. And, how will your business replace you? And finally, how is your family going to obtain best and maximum value for your ownership if any of those things have occurred? With an Atlanta Family Wealth Planning lawyer, we can help you through your buy/sell agreement process.
Understanding the Buy/Sell Agreement
Owners need a well-drafted buy/sell agreement to aid in the smooth transition of ownership and provide a mechanism to liquidate a deceased or disabled partner’s ownership for his family. Most businesses do not have such an agreement. The company was formed and the owners focused on building their business prior to worrying about such things. Like wills and estate plans, most people just don’t want to deal with these issues.
The Two Forms
Buy/sell agreements typically take one of two forms – a cross-purchase plan, or an entity redemption plan. In each case, life insurance is obtained to cover the owners’ lives – in one case the insurance is held by the other owner(s), in the other the Company holds the insurance on all owners. Upon the death of an owner, the insurance benefit is paid to buyer (the other company) to be used to buy the deceased owner’s interest from his or her estate. In the case of a cross-purchase plan, if there are more than two owners, the plan can become administratively complex and burdensome. In both cases, the premiums paid are not deductible, and the proceeds are generally received tax free. Other tax considerations may come into play, so you should consult your financial and tax advisors.
The benefits of a buy/sell agreement are numerous:
- There is a funding source to buy out what is usually an illiquid asset
- There is a smooth and orderly transfer of ownership and management of the business
- Potentially avoids having an unqualified person become a co-owner
- Potentially avoids ownership/management struggles which can hurt the business
- Insurance held by company can be shown as asset on balance sheet (whole life)
- Peace of mind
Buy/sell agreements can and should address how to deal with other contingencies like long-term disability, retirement, divorce, bankruptcy of an owner, and an owner’s drug and alcohol abuse. While insurance may not be available for all of them, it is often more desirable to ensure you have a plan to get a partner out of the business if need be than to leave such matters unaddressed. Setting forth an orderly way to conduct a “business divorce” is usually preferable to fighting about things later on where such distractions will inevitably hurt the business.
Terms of Effective Buy/Sell Agreements
As you think about the possible terms of a buy/sell agreement, there are many issues which need to be addressed in detail. Effective buy/sell agreements must answer the follow questions:
- Which events should trigger a purchase event?
- How do we value the business upon the occurrence of an purchase event?
- Can we get affordable insurance to cover the specific risk?
- If we can’t get insurance, what payment terms can the owner/company afford to buy out a departing owner?
- What is the most tax effective way to structure the buy/sell agreement?
Contact Your Atlanta Family Planning Wealth Attorney
At Cohen Pollock Merlin Turner, we draft and prepare buy/sell agreements for our business clients as part of an overall family wealth plan. Please contact our Atlanta corporate team to discuss getting your agreement reviewed or getting a new agreement prepared.