Buy-Sell Agreements

by | Oct 25, 2010 | Business, Tax

Who needs a buy-sell agreement?

A buy-sell agreement is needed for every co-owned business.  Every day that value is added to the business increases the financial risk when this agreement isn’t in place.  Business owners often ask CPAs about how useful buy-sell agreements can be for them. The answer is “very.” A buy-sell contract helps solve many problems when something happens between business owners. It lets business partners, or shareholders of a corporation, agree to the terms and conditions of a future sale.

What is a buy-sell agreement?

A buy-sell is an agreement between the owners of a business which describes what happens to the business if one of the owner’s dies, becomes disabled, retires, divorces, or wishes to sell their interest in the business. Typically, the buy-sell agreement provides that the surviving owner of the business will purchase the deceased or withdrawing owner’s share of the operation. In other words, a buy-sell agreement is a sort of prenuptial agreement between business co-owners.

The agreement should set forth the purchase price to be paid or should provide a formula for determining the price. Perhaps more importantly, the agreement must have a mechanism for providing the funds needed to make the purchase.

There are two typical buy/sell agreement structures

Most business owners purchase one of two plans, the cross-purchase plan or the entity purchase or stock redemption plan.

  • Cross-purchase plan – Each business owner purchases a life insurance policy on each of the other owners. When an owner dies, the surviving owner uses the death benefit to purchase the deceased owner’s share of the business.
  • Entity purchase or stock redemption plan – In an entity redemption plan between owner-employees, each owner enters into an agreement with the business for the sale of their respective interests to the business.

As a part of this agreement, the business will purchase separate life insurance contracts on the lives of the owners. The business will pay the premiums and will be the owner and beneficiary. When an owner-employee dies, his or her share of the company will pass to the heirs of his or her estate. The business may use the proceeds from the policy to purchase the interest from the estate.

What are the business benefits of a buy/sell agreement?

A buy/sell agreement gives employers peace of mind knowing that their business is in capable hands should they no longer be able or want to manage it. It also:

  • Provides money to create a fair market value exchange
  • Promotes equitable and orderly transfer of wealth, ownership and management
  • May offer tax advantages
  • Guarantees heirs a buyer for assets they may not know how to manage
  • Provides heirs with cash to pay estate debt, expenses and taxes

To draft an agreement to satisfy all parties involved one must understand the business owner’s needs and goals, and educate the owner’s on the impact of the transaction and their options.  Kruger & Clary, CPA’s can help business owner’s understand the details of a buy-sale agreement and work with a team of professionals to ensure an agreement is properly constructed. 

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