Jonathan M. McGee 2013-03-06 00:46:28
Buy-Sell Agreements for Business Succession Planning Jonathan M. McGee, JD, CPA is a business attorney and is the founder of the McGee Law Firm, LLC located in Scottsdale, Arizona. Mr. McGee is licensed to practice law in Arizona, California and Nevada. Mr. McGee is a native of Arizona and earned is Juris Doctor from Arizona State University where he was a member of the Arizona State Law Journal. Mr. McGee also practices in the areas of estate planning and real estate. For more information regarding Mr. McGee or the McGee Law Firm, please call (480) 729-6208 or visit www.mcgeelawaz.com. Many entrepreneurs and small business owners lack an adequate business succession plan. Business owners tend to focus their initial energy on the operation, growth and survival of their business. While basic business succession planning is easiest to accomplish at business formation, the possibility of death, disability, divorce, retirement and termination are the last things such entrepreneurs want to discuss at that time. However, that is an important discussion to have when beginning a new business venture. Business owners have multiple options when planning for the disposition of a closely held business. Options include a sale of the business to a third party; a sale of an ownership interest to an existing business partner; a sale under a buy-sell agreement; a sale to an employee stock option plan (ESOP); implementation of a gifting program to transfer ownership of the business to the next generation over time; an outright gift to successors; or some combination of the above. Each business and each family is unique so the planning tools may differ from one business to the next. However, the most commonly used tool to plan for business succession is the buy-sell agreement; such agreements will be the focus of this article. A buy-sell agreement is an agreement between the owners of a business whereby the owners or the business may (or must) buy out the shares of another owner at a predetermined price upon the occurrence of a specific event. Entrepreneurs initially tend to view buy-sell agreements as a tool to address the non-desirable conduct of their business partners, such as withdrawal, discharge, divorce, and bankruptcy. While these are important considerations, it is important that attorneys inform their business clients about how a buy-sell agreement can act as a powerful business succession planning tool for them in the event of incapacity or death. The two types of buy-sell agreements most utilized are a cross-purchase agreement and an entity purchase agreement. These agreements are usually funded with life insurance. Cross-purchase agreements typically require each owner to take out a life insurance policy on each of the other owners. Upon a death or other triggering event, the remaining owners buy the deceased owner’s interest with the insurance policy proceeds. Under an entity-purchase agreement, the entity owns the insurance policy and buys the owner’s interest upon the triggering event. Selection of the type of buy-sell agreement requires analysis of multiple factors, including the number of owners, the type of funding method and various tax issues. Cross-purchase agreements are more common and are usually preferred if there are only two or three owners. Entity purchase agreement may be preferable where there are many owners or where there is a significant disparity in the ages and/or insurance premiums among the owners. Entity-purchase agreements do not confer the same step-up in basis that is received under cross-purchase agreements and entity-purchase agreements could cause the purchase price to be included in the estate of an owner who dies holding more than a 50% interest in the entity. Thus, the tax implications of an entity purchase agreement must be carefully reviewed with business owner. Another difficult discussion concerns the valuation method to be utilized and the terms of the purchase. Valuations options include fair market value, fair value, formula pricing, book value, a stated price, value of insurance proceeds or a hybrid. Fair market value tends to be the most appropriate in theory, but determining that fair market value can be costly, lengthy and contentious, particularly where multiple appraisers are involved. A stated or agreed upon value provides for a price certain and quick administration of the sale, but the owners must actually agree upon a price at each review interval for this method to work as intended. My preference is to use a hybrid method that takes into account the value of the insurance policy and utilizes either fair market value or a stated price which is updated at least annually. The time period for payment of the purchase price could be 90 days or less so long as the triggering event is one that is funded by insurance.1 When properly drafted for the clients needs, a buy-sell agreement can ensure that a business interest is promptly transferred with minimal disruption to business operations and quickly compensate the family of the deceased owner. It is important for the business attorney to consult the business owner’s estate planning attorney in order to ensure that the buy-sell agreement does not conflict with the client’s existing estate plan. A buy-sell agreement should not be a separate stand-alone plan; rather it should act in concert with the estate plan. If the entrepreneur does not have an existing estate plan, they should be encouraged to engage the services of an estate planning attorney to draft a plan that meets the business owner’s personal and business needs. In summary, the buy-sell agreement is an effective and relatively simple first step in planning for business succession. Where appropriate, however, buy-sell agreements should be supplemented with more advanced estate planning and business succession tools.
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