You’ve probably come to accept the importance of a will for your life but what about a similar plan for your business? What happens if one of the owners in a partnership can no longer continue? Advance planning ensures a continuity of ownership and management without having the departing owner’s estate unsettled. An unplanned buyout might compromise the liquidity of a business in order to fund a significant buyout. Disabled or deceased owners will also want their families fairly compensated for their share of the business. A properly drafted buy/sell agreement can achieve many significant business goals:
- One Way Buy/Sell Agreement
- Buy/Sell For Partnerships
- Buy/Sell for Closely Held Corporations
- Buy/Sell for Sole Proprietors
Buy/Sell for Partnerships
Partnerships are automatically dissolved with the death of one partner; therefore, a buy-sell agreement is pretty important to have. In this case, a buy-sell agreement would sell the deceased’s interest in the company to the surviving partner(s) at an agreed to price. For partnerships there are two different plans:
- Cross-Purchase Plan – in this plan each partner buys a life insurance policy on each of the other partners. The partnership itself is not a participant in the agreement. Each partner owns, pays the premium payments and is the beneficiary of the insurance policies on the other partners in an amount equal to his share of the purchase price set forth in the buy-sell agreement. The proceeds are used to purchase the partner’s business interest from the heir’s of the deceased.
- Entity Plan – in this plan partners enter into an agreement with the partnership who owns, pays the premium payments and is the beneficiary of the policies. When a partner dies, his/her interest is purchased from his/her estate by the partnership at the buy-sell agreement price and the interest is then divided among the surviving partners in proportion to their own interest.
While the premium payments are not tax deductible, the benefits are tax-free.
Buy/Sell for Closely Held Corporations
Unlike a partnership, a closed corporation that has shareholders does not cease to exist with the death of a shareholder. For closed corporations, there are also two different plans:
- Cross-purchase plan – each stockholder owns, pays for and is the beneficiary of life insurance on the other stockholders in amounts equivalent to his or her share of the purchase price. The corporation is not a party to the agreement. The surviving stockholders purchase the interest of the deceased stockholder as individuals from the estate of the deceased stockholder. This is much like the cross-purchase plan. Of course, the more shareholders you have, the more cumbersome this type of plan becomes.
- Stock redemption plan – the corporation, instead of stockholders, purchases insurance policies, based upon the stockholders interest in the company, pays the premiums and is the beneficiary on the lives of each shareholder. Upon the death of one a stockholder, proceeds are paid to the corporation who then buys the deceased’s stock from the deceased’s estate. Premiums are not taxed deductible but the proceeds are received income tax free.
Any agreements and insurance polices within a business must be integrated with the overall plan and objectives of the business. Careful consideration must be given to the selection of the plan which is right for your business and to the method of funding your plan.
Buy/Sell for Sole Proprietors
Unless a sole proprietor has a family member or a close relative to turn the business over to and feels comfortable the owner’s desires for his/her family members will be served, the options are pretty limited. The business can be closed, sold to an outsider, although that may be difficult, or, it can be sold to one or more competent and close employees. An agreement would outline the employee’s obligation to buy, the price the employee(s) will pay for the business and the method of payment and the employee(s) would takes out insurance policy on the owner. If the owner dies, the death benefits of the insurance policy would be used to buy the business from the owner’s estate.
Where there is nobody to purchase the business and the value of the business would be lost, the sole proprietor/owner could elect purchase a life insurance policy, where upon his or her death, the insurance company in effect becomes the second party to the agreement. They would pay the proceeds to the family which would replace the lost value to the family.