A typical small business owner spends so much time
attending to immediate tasks that planning for the future is often
neglected. This is too bad, because business owners who neglect
planning now may cause their families and business partners to pay
dearly for this oversight later.
If you're a business owner, you may not have
planned sufficiently for the future if a buy-sell agreement hasn't
been drawn. A buy-sell agreement decrees how a business, or share of
a business, will be transferred upon death, disability or retirement.
A buy-sell agreement can be between partners, between a business
entity and its stockholders, or between an owner and a key employee.
It predetermines who will receive a business or its share, how the
sale or transfer will be funded and it provides a means for paying
personal estate taxes after the transfer.
There are three types of buy-sell agreements and
all determine the value of the business through an updated business
valuation or a formula derived from an older valuation. The first is
a stock redemption plan, which is an agreement between a corporation
and its shareholders. A second type is a cross-purchase plan, which
is an agreement usually among shareholders or partners. A third,
less known option is a "wait-and-see" buy-sell plan, offers
flexibility and tax and economic advantages that take the best from
the first two options. In this buy-sell scenario, a corporation can
exercise its buy option or waive its right, thus triggering the
cross-purchase option to kick in.
Regardless of which buy-sell plan is chosen,
business owners should consult with a professional to help avoid
tricky tax and procedural pitfalls. And, equally important, a
financial professional can present appropriate funding options.
Without them, all the planning in the world can be for naught.
When a business owner is disabled or opts out of
the business for other reasons, other owners get first crack at that
share of the business. Of course, they need the money to acquire
those shares. When a business or its shares become available because
of the death of an owner or shareholder, surviving owners again get
the first option to buy, even though the business interest is usually
willed to a family estate. Most buy-sell plans include the
stipulation that surviving family members, if not previously involved
in the day-to-day business operations, sell their interest to
surviving owners. The cash received for this interest helps to meet
family estate tax obligations and the business is in the hands of
people best qualified to run it.
Self-funding, borrowing and insuring a buy-out are
the three basic ways most buy-sell plans are funded.
With self-funding, surviving owners or
shareholders can either pay for the business interest outright or
through an installment plan. Buy-out funds can also be accumulated
through the establishment of a sinking fund, basically a savings plan
in which business owners put aside money on a regular basis for the
sole purpose of buying shares when they become available. While this
funding arrangement helps money accumulate in the future, all the
while earning interest, borrowing provides the money upfront with
interest payments figured into future payments. All three
arrangements have a variety of holes should the unexpected happen.
What if death or disability occurs before funds
have accumulated to meet the buying price? What if borrowing becomes
tight because the departure has an adverse affect on business? Can a
deceased owner's estate afford to wait for an installment plan?
That's where insurance comes in. Bought by either
the company or by partners on each other's lives, insurance is a
method of providing cash when it's needed. Through a variety of
insurance programs such as split-dollar, in which an insured owner
and other partners split the cost, tax-advantaged savings can be
accomplished now while future payout is guaranteed*. Whole life
insurance, which builds cash value, can also provide needed funds
when events other than death trigger a buy-out clause**.
And many companies now sell disability insurance to specifically meet
buy-sell needs.
The existence of a buy-sell plan ensures the
orderly transition of a business, and a proper funding vehicle
ensures the money will be there when the time comes. Plan for the
future now. Your business depends on it.
*Guarantees
are dependent on the claims-paying ability of the issuing company.
**Policy
loans and withdrawals may reduce the policy’s cash value and death
benefit and may results in a taxable event.
This
information is not intended as tax or legal advice. Please consult
with your Attorney or Accountant prior to acting upon any of the
information contained in this article.
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