- Estate Planning
- Estate Planning and Buy/Sell Agreements
Written By:Scott Glatstian
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About fifty-six percent of Americans understand the value of estate planning for their families. People will prepare the proper documentation to protect and take care of family members’ inheritance in the event of their deaths. However, estate planning isn’t exclusively for the betterment of family and friends but also their business. Not having the proper documentation for all parties will cause problems for families and business affairs.
Imagine if John and Nick opened up a booming bookstore/coffee shop. Both men are involved in all aspects of the business. Suddenly, Nick has a heart attack and passes away. Because Nick owned half of the company, his half was passed down to his wife, Lily. This situation is difficult for John because Lily has no business experience and needs to learn about the coffee business. John is left with a dilemma that could have been fixed with the proper business arrangements. If business owners plan correctly, the living business partner can keep running the successful business.
Business owners should take proper measures for the betterment of their partners and business in the event of death. A buy and sell agreement is a great way to protect business assets and partners, and 44% of businesses use this method to plan for the future of their company.
What Is a Buy and Sell Agreement?
A buy and sell agreement is a legally binding contract that details how a partner’s share in the business will be reassigned if the other business partner dies. Although this agreement is used when an owner dies, it can also be applicable for an owner when they retire. This agreement is also referred to as a business will.
Usually, in this agreement, the remaining shares will be sold directly to the other partners. It can be expensive to buy the shares of the deceased or retired partner. This is why life insurance policies are commonly used in buy and sell agreements. Life insurance will alleviate the financial burden of buying the company’s shares.
This agreement is a good option for individuals looking to maintain the business with people they already trust. The stipulation of selling the shares back to other partners prevents outsiders from coming into the business.
Why Are Life Insurance Policies Important to the Agreement?
There are two ways life insurance is bought when using it for agreements. The company or the individual partners will buy life insurance policies for each other’s lives. The policyholders will receive the payout benefit when the other partner dies. That money will be used to buy out the other person’s share.
When business owners buy life insurance, the amount should be considered. The life insurance coverage should equal or exceed the value of the interest in the business they would be purchasing. That way when the policy owner will have enough funds to buy the owner’s shares, even if the value of those shares increases over time. When the policy owner pays out the deceased partner’s shares, that money will be given to the family or whoever would have inherited the business interest. A good life insurance policy for this “business will” ensures enough funds can benefit both the business and the real family.
Business owners should strongly consider creating a sell-and-buy agreement because it has great benefits.
- Life insurance will create a lump sum of money to buy the shares of the previous partner.
- Cash from the life insurance policy will usually be paid quickly, making the transactions easily settled.
- If there is sufficient cash value to the life insurance policy, the funds can be retrieved when the owner decides to retire.
If life insurance policies are chosen to fund the agreement, it’s important to be aware of taxes. Premiums aren’t tax deductible for companies. It’s also not considered taxable income for the owners. However, certain business structures could trigger some tax repercussions. It’s always a good idea to seek expert advice when creating a buy-and-sell agreement. A lawyer and a financial advisor can direct you to the best steps for funding the agreement.
Types of Buy-Sell Agreements
Business owners can choose from different forms of buy and sell agreements. Having other options will make it easier to have an agreement that fits your unique business situation.
Cross-Purchase Plan: This plan requires each person to take out a life insurance policy on each owner. The owners will pay the premiums on the life insurance, and they are each beneficiaries of the policy. When the owner passes or decides to leave the company, the other owner will receive the benefits and purchase the deceased or retired person’s shares in the business. If the company is more extensive and has multiple business owners, then each owner must take out a policy on each owner.
Entity Redemption Plan: In this plan, the business will buy life insurance policies for the owners. The company will pay the premiums and will get the benefits of the life insurance policies. The owners will have an agreement with the business entity for their shares in the business. When an owner dies, their stakes in the company will go to the heirs of the deceased owner. The business can use life insurance to buy shares from the heirs.
Hybrid Plan: This combines both cross-purchase and entity redemption plans. The owners and the business will have the flexibility to create a plan that works for the specific situation. This also allows certain employees or longtime company officials to purchase the shares of the retired or deceased owner.
When people decide to handle their business affairs with a buy-sell agreement, there is key information that should be included in the contract. The agreement should consist of the following:
- Triggers for buyout events such as death, disabilities, bankruptcy, or retirement
- A valuation of the company’s overall equity
- A method to fund the buyout, such as the life insurance policies
- Determine what rights and purchase obligations a person has
- Determine how the shares will be distributed among the other owners
- Identify all business owners attached to the company
Where Can You Find Help?
Even after you leave, preparing for your future business affairs is essential to a thriving business. A buy-and-sell agreement is a great tool to use for business preparations. An agreement such as this will have many moving pieces. Thus seeking an attorney to help oversee the agreement’s creation is a good idea. You can get started on your business agreement by contacting Rosenblum Law for a free consultation.
About The Author
Scott is a graduate of Syracuse University College of Law and received his undergraduate degree from Rutgers University.Read More
How to Cite Rosenblum Law’s Article
Scott Glatstian (May 12, 2023). Estate Planning and Buy/Sell Agreements. Rosenblum Law Firm, https://rosenblumlaw.com/estate-planning/estate-planning-and-buy-sell-agreements/
Scott Glatstian "Estate Planning and Buy/Sell Agreements". Rosenblum Law Firm, May 12, 2023. https://rosenblumlaw.com/estate-planning/estate-planning-and-buy-sell-agreements/