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Buy / Sell Agreements
Sole proprietorships, partnerships and small corporations all need to
consider what happens if the owner or one of the partners or
shareholders dies or becomes disabled.
- Who will purchase the company or the deceased partner’s or
shareholder’s interest? - What is a fair price?
- When will the sale be made?
- Will the deceased owner’s/partner’s/shareholder’s families be
given fair market value for the asset?
A buy-sell agreement is important to resolve a lot of problems dealing
with employees, creditors, suppliers and the deceased person’s family.
A buy-out sell agreement provides the necessary money to ensure a
smooth transition should an unexpected event occur. It is " the will" for the
business. A plan needs to be in place and a method of funding that plan
must also be available.
There are several options for business owners to fund a buy-sell
agreement:
they can wait and see –
- You can use your personal funds to buy-out your partner’s stock.
- You can borrow funds if the surviving partner(s) can borrow enough
to purchase the assets of the deceased partner. - You can set-up a savings account within the company in anticipation
of an event like this happening but if you are a corporation there may
be accumulated earnings tax problems. - You can buy life insurance.
Sole Proprietor
The buy-sell agreement can be used to ensure enough funds are available
so that a relative or trusted yey employee can purchase the business.
- an agreement is prepared which sets forth the employee’s
obligation to buy, the price the employee(s) will pay for the business
and the method of payment - the employee takes out a life insurance policy on the owner. The
employee is the owner of the policy, the person who pays the
premiums and the beneficiary.
If the owner dies, the death benefits of the insurance policy would be used
to buy the business from the owner’s estate.
Partnership
Partnerships are automatically dissolved with the death of one partner;
therefore, a buy-sell agreement is very important. 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.
Additionally, none of the premium payments in the above plans are tax
deductible; however, the benefits are tax-free.
Small Corporation
Unlike a partnership, a closed corporation (i.e. a small number of
shareholders who run the business) does not cease to exist with the death
of one of its shareholders. 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 plan is like the
cross-purchase plan described in the partnership section above.
Obviously, the more shareholders the more difficult this plan
becomes.
- Stock redemption plan – the corporation, rather than the
stockholders, purchases the insurance policy, pays the insurance
premiums and is the beneficiary on the lives of each shareholder.
The amount of insurance on each stockholder is equal to the
proportionate share of the purchase price. Upon the death of one of
the stockholders, the death benefits 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.
