Do you own a business with one or more individuals? Undoubtedly, your interest in the business represents a substantial part of your net worth and is likely your “pride and joy.” So it’s normal if your fondest wish is for the business to continue long after you’re gone or for you to keep it running if a co-owner or partner dies first.
But circumstances can get in the way. If adequate provisions aren’t made, the business may flounder if a leadership void isn’t filled. Or bitter family disputes can tear the organization apart. In the end, a “distress sale” may leave your heirs with substantially less than the company’s current value.
Fortunately, disastrous results may be avoided if you have a buy-sell agreement drafted during your lifetime. The agreement can dictate how the business is sold, to whom and for how much. Life insurance policies are often used to fund the transaction.
Buy-sells in a nutshell
A buy-sell agreement may be used for virtually every type of business entity, including C corporations, S corporations, partnerships and limited liability companies. Typically, it applies to the shares of stock and any business real estate held by respective owners. Although variations exist, the agreement essentially provides for the sale of a business interest to other owners or partners, the business entity itself or a hybrid. Alternatively, the agreement may cover a sale to one or more long-time employees.
The agreement, which is typically signed by all affected parties, imposes restrictions on the future sale of the business or property. For instance, if you intend to leave a business interest to your children, you may provide for each child to sell or transfer his or her interest to another party or parties named in the agreement, such as grandchildren or other relatives. Similarly, the agreement may include provisions relating to the distributions of assets to trusts and potential divorces of heirs. (Be aware that special rules may apply in community property states.)
Significantly, a buy-sell agreement often establishes a formula for determining the sale price of the business and its components. The formula may be based on financial statement figures, such as book value, adjusted book value, or the weighted average of historical earnings, or a combination of variables.
Understanding the benefits
As you might imagine, having a valid buy-sell agreement in writing removes much of the uncertainty that can happen when a business owner passes away. It provides a “ready, willing and able” buyer who’s arranged to purchase shares under the formula or at a fixed price. There’s no argument about what the business is worth among co-owners, partners or family members.
The buy-sell agreement addresses a host of problems about co-ownership of assets. For instance, if you have one partner who dies first, the partnership shares might pass to a family member who has a different vision for the future than you do.
An agreement also provides for a smooth transfer of the business in advance of specified events, such as the death of an owner. This can help minimize disruptions while the business recovers from the loss.
Review your plan
Your estate planning advisor and an attorney can work with you to design a buy-sell agreement that helps preserve the value of your business for your family. After you have an agreement in place, review it periodically to be sure that it continues to meet your expectations. For additional questions about buy-sell agreements, contact our Family Wealth and Individual Tax Group.