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Succession Planning For Small Businesses
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Article 7: Buy-Sell Agreements: An Integral Tool
A buy-sell agreement is an essential part of succession planning for any closely held business
This is a legal document that details business continuation and succession plans in the event of an owner’s retirement or sudden and unexpected death or disability.
A buy-sell agreement provides the mechanism for an orderly transfer of business ownership, whether to surviving family members or non-family business partners. It creates an immediate market by which an owner’s interest can be translated into cash through the buyout of his or her shares at a pre-determined price.
Just as importantly, the agreement spells out the terms of the payment and places a binding value on the business for federal estate tax purposes. Buy-sell agreements:
- Help ensure a smooth transition of business control and ownership to the successor owners
- Provide much-needed stability for employees and customers
- Help ensure that a non-participating spouse receives fair value for his or her shares while protecting the viability of the business
Most buy-sell agreements are funded with life insurance on the business owner, purchased by heirs, partners or the business itself. This provides a ready source of cash that enables surviving partners to buy the deceased partner’s interest, ensuring that the deceased’s heirs receive full value for their shares regardless of the continued success or failure of the business.
There are two common types of agreements:
- Cross-purchase plan — Each surviving partner agrees to buy the interest of the deceased partner. This type of plan works best when there are only two partners, since partners need only purchase insurance policies on each other.
- Stock redemption (or entity purchase) plan — The business (instead of surviving partners) buys the interest of the deceased partner, which is then divided among the surviving partners. This type of plan is usually best when there are more than two partners so that partners don’t have to purchase multiple insurance policies on each other.
In a family business, a child who is active in the business can buy life insurance on his or her parent(s) to finance the purchase of the company from non-business heirs. Insurance proceeds are income tax free, and the proceeds are not included in the decedent’s estate.
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