BUSINESS SUCCESSION PLANNING
The death of a partner or major shareholder in a business can have devastating effects on both the business, surviving partners as well as the deceased partner’s surviving family. The business is concerned with gaining control of the deceased partner’s interest at a fair price so that it can continue operations without interference from the surviving family members. The family members are most concerned with receiving as much money as possible for their interest in the business and for capital that may be needed for estate settlement purposes.
The Need for a Written Agreement
In the absence of a written agreement, the competing interests of the business and the family members could lead to major conflicts, litigation and possibly the forced liquidation of the business. A buy-sell agreement can ensure that the business interest of the deceased partner will transfer in an orderly manner to the benefit and satisfaction of all parties. With a buy-sell agreement in place, the stability of the business for it clients, employees and investors (or creditors) is more assured.
Key elements of a buy-sell agreement include a mutually agreeable sales price and terms of the sale. The agreement needs to be funded in order to ensure that the capital is available at the time of the death or permanent disablement of a partner. While there are a few methods to fund the buy-sell agreement, life insurance provides a cost effective means of creating the capital necessary to buy out the interests of the family and establish a reserve for the business to use to continue its operations.
Types of Business Owner Buy-Sell Arrangements
Entity Plan: Under this arrangement, used when there are multiple owners, each of the business owners has a separate agreement with the corporation or partnership as the entity. The entity, per the buy-sell agreement, will buy the deceased partner’s interest at his or her death.
Cross Purchase Agreement: Used in situations where there are small number of owners, a cross purchase agreement is established between each of the owners. At the death of one of the owners, the surviving owners agree to buy a proportionate share of the deceased owner’s interest.
Hybrid Trust: This arrangement is used to overcome the shortcomings in Entity Plan and Cross Purchase Agreement especially where there are large number of business owners. A Trustee can be appointed to ensure its orderly execution.
Buy-Sell arrangements are a simple, yet effective way for business owners of privately held companies to plan for the orderly transfer of business interests where two or more owners are actively involved in the business. In addition to securing the needs of the surviving family members and ensuring the continuation of the business, a buy-sell arrangement also ensures each owner that there is a buyer for their business interest at a fair price.
Business succession planning involves legal, tax and personal financial issues. Guidance from a qualified attorney or tax professional is strongly recommended.