BUY-SELL AGREEMENTS
Owner's of a closely held business need to consider how the ownership of their business is to be transferred upon certain life changing events. Business succession planning is a key element of any business owner's financial plan. There are several key elements to consider when creating a business succession plan. One of the more common ways to transfer ownership is through a buy-sell agreement between business owners. Most often this agreement will serve as the key element to any succession plan.

Definition
A contractual agreement outlining how the ownership of a business is to be transferred upon one or more of the following events:

  • Retirement
  • Death
  • Disability
  • Bankruptcy
  • Divorce

Typically, the ownership is transferred through the sale of interest in the company. The price of the sale is determined by a formula outlined in the contract.

Advantages of a Buy-Sell Agreement
There are many advantages to this type of agreement. When selling interest in a business, it is difficult to guarantee that a market will exist. When there is no market for the sale of a business the owner or the owner's family will have to retain the interest. This can create an unwanted burden for the family or withdrawing owner. Also, in the instance of the death of an owner a large estate or death tax liability may exist. A buy-sell agreement creates liquid assets available for the payment of the estate or death tax. The agreement can also establish the value of an owner's business interest thus, easing the estate planning process. Most importantly, an agreement will guarantee the proper continuation of the business. This decreases the overall risk taken by the owner's of a business, increases a businesses credit rating, and makes the business more favorable to would be investor's.

Practice Question:
Bobby is one of three owners in ABC Corporation. All three owners have equal interest in the business. The owners have decided to establish a cross purchase buy-sell agreement funded with life insurance. According to the contractual agreement the business is worth 10 million dollars. How many life insurance policies will Bobby need to purchase and how much life insurance must he purchase on each owner to fully fund his portion of the agreement?

A. 1; $10,000,000
B. 1; $3,333,333
C. 1; $1,666,666
D. 2; $3,333,333
E. 2; $1,666,666

Answer: E
Bobby would need to purchase 2 policies (one for each owner other than himself). If the value of the business has been established as $10,000,000 each owner owns $3,333,333 of the business. If one of the owners was to die their family would need to receive $3,333,333 for the value of his/her share. Therefore each owner must buy 2 policies valued at $1,666,666 (2 * 1,666,666 = $3,333,333) a piece.
Structure and Tax Considerations of Buy-Sell Agreements

Related Articles
  1. Small Business

    Keeping Your Business Investment on Track

    Business owners need to track business value and performance like any other investment.
  2. Small Business

    Which Type of Organization Is Best For Your Business?

    Learn the differences between the types of business organizations so you can determine how to best structure your business for tax and liability limitations.
  3. Financial Advisor

    Buy-Sell Agreements: What Advisors Should Know

    Having a buy-sell agreement in place can cement a succession plan with a fair price and ensure a seamless transition to the new owner.
  4. Financial Advisor

    Financial Advisors Should Cater to Small Business Needs

    One of the most precious commodities for small business owners is time, which presents opportunities for financial advisors who cater to these clients.
  5. Small Business

    4 Management Tips for a Seasonal Business Owner

    Learn about ways for business owners running seasonal businesses to ensure the lives of their businesses and promote success through the off-season.
  6. Small Business

    Exit Strategies for Business Owners

    Ideally, an exit strategy is planned early in the life of the business, begin with the end in mind.
  7. Small Business

    Business Owner Compensation: Marathon or Sprint?

    Which is better, sinking all of your money into your business or paying yourself along the way?
  8. Insurance

    Will Insurance Keep Your Business Safe?

    Skilled employees are key to a successful business. Find out how to avoid a financial setback if they leave.
  9. Insurance

    3 Life Insurance Tips for Business Owners

    Here are three tips for business owners to use life insurance to take care of their families.
  10. Small Business

    If Your Business Doesn't Sell, Can You Still Retire?

    Many business owners have the dream of one day selling their business. Yet most will never be sold.
Frequently Asked Questions
  1. What is Common Stock and Preferred Stock?

    Learn about the differences between common and preferred shares. Explore situations where preferred shares have more favorable ...
  2. Can CareCredit be Used for Family Members?

    Learn more about the available options that CareCredit offers to pay for out-of-pocket medical procedures with little to ...
  3. What is a Wash Sale?

    The Wash-Sale rule was established to forbid a loss deduction of a security sold.
  4. Were Collateralized Debt Obligations (CDO) Responsible for the 2008 Financial Crisis?

    Collateralized debt obligations are exotic financial instruments that can be difficult to understand, Learn the role they ...
Trading Center