The Buy-Sell Agreement: An Essential Tool for Jointly-Owned Small Businesses

One of the most common scenarios in business is for the owners part ways. This can occur under a variety of circumstances, ranging from disagreement over the continued management and direction of the business, to incapacity or death. Due to a lack of planning, this transition is rarely smooth.

Fortunately, a contingency plan can be created in advance by using what is known as a "Buy-Sell agreement". A well-planned and well-drafted Buy-Sell agreement is an excellent tool for business owners who seek to avoid disruption of a business upon the departure of one or more of its owners.

A Buy-Sell agreement is useful regardless of the entity form being used (LLC, corporation, etc.), and can be flexibly structured to meet a business's needs.

Most Buy-Sell agreements restrict the sale of an owner's business interest to an outsider. In a "cross-purchase" arrangement, the remaining business owners may be required to purchase the departing owner's interest for a fixed price, or for a price to be determined based on an appraisal or stated valuation formula. Purchase payments may be made in one lump sum, or may be structured over time.

As an alternative to a mandatory purchase arrangement, business owners may choose to utilize either a purchase option or a right of first refusal. A purchase (or "buy-out") option gives the remaining owners the option to purchase the departing owner's interest for a predetermined sum. A right of first refusal, on the other hand, gives the remaining owners the right to beat any third party's purchase offer.

A "stock redemption agreement" (also known as an "entity-purchase agreement") is another common form of a Buy-Sell agreement. In this type of agreement, the entity itself purchases the ownership interest of the departing owner. This type of Buy-Sell agreement is well suited for businesses with many owners.

Regardless of whether a cross-purchase, entity-purchase, or a hybrid of the two is used, cash will invariably be needed to purchase the departing owner's interest. Life insurance is commonly used for this purpose, but for obvious reasons is only available in the event of the death of an owner.

When using a stock redemption agreement, a business may choose to fund the buy-out with accumulated earnings and corporate profits. If this type of arrangement is utilized, care should be taken to avoid any unecessary and unexpected tax consequences.

Ultimately, business relationships really are much like romantic relationships. They require a lot of skill and a lot of effort to succeed. Even if the owners are on the best of terms, an unexpected death can really leave a business in a lurch. In the absense of a Buy-Sell agreement, the decedent's estate (i.e. spouse or children) will take over his or her ownership interest. Generally, the decedent's heirs lack the skills or the temper necessary to competently assume the decededent's ownership responsibilities. By using a Buy-Sell agreement, existing owners can effectively maintain valuable control over who they will be doing business with in the future. Of course, the Buy-Sell agreement also works to the benefit of the decedent's heirs, in that they will receive the purchase monies due upon the transfer of the decedent's ownership interest.

These are just a few of the many reasons I strongly encourage anyone who owns a business with others to consider the use of a Buy-Sell agreement. If you would like more information related to Buy-Sell agreements or other small business issues, please feel free to contact us.

Estate Planning Basics

The idea of planning one’s estate is daunting for most. However, with the help of qualified professionals, the process can actually be enjoyable. While planning for death does remind us of our mortality, it should also remind us of our life and the good things around us, including our family and friends. And, it’s for our family and friends that we plan.

I have seen countless estates administered, some with pre-planning in place, others without it. Without exception, estates without planning in place are costly, time-consuming, and generally stressful to administer. Estates that have been properly planned, on the other hand, can be administered much more easily, much more quickly, and nearly always less expensively.

In addition to time and cost savings, some of the benefits to planning one’s estate include:

• The ability to name the people to whom you wish to give your assets and know that your wishes will be carried out;
• The ability to arrange your estate so that it pays as little in estate taxes as possible; and
• The satisfaction of knowing that your financial affairs are in order and that you’re not bequeathing a costly administrative nightmare to your loved ones.

Having a basic estate plan in place is important, regardless of your net worth. Such a plan ensures that your family and financial goals are met after you die.

An estate plan has several elements: a will, power of attorney, and an advance healthcare directive (medical power of attorney). For most people, a trust and life insurance also make sense.

The first step in planning your estate is to take an inventory of your assets. Your assets include your investments, retirement savings, insurance policies, and real estate or business interests. Once you have done this, decide how you would like your estate distributed and whether you would like to place any restrictions or conditions on the distributions.

If you have minor children, it is always wise to have a Will, even if you have a Trust as well, as a Will is the best place to name your children’s guardians.

In addition to the basic estate planning documents that everyone should have, Living Trusts (also known as Revocable Trusts) are also wise to consider. Living Trusts are legal mechanisms that let you put conditions on how and when your assets will be distributed upon your death. Unlike Irrevocable Trusts, Living Trusts allow you to continue to have complete management power over and access to your assets during your lifetime. Upon your death, the terms of your Trust will govern the distribution of your assets. By using a Living Trust, your heirs will most likely save significant time and money in administering your estate.

If you would like more information regarding setting up an estate plan, please give us a call to schedule an appointment for a free consultation.

Irrevocable Life Insurance Trusts

Life Insurance is an investment. Like other investments, its value is included in the total value of an estate when an individual passes away. Where the value of an estate exceeds the available estate tax exemption (see below), the excess amount will be taxed at up to 45%!

Therefore, if an individual has a large life insurance policy, he or she may unwittingly cause a significant tax liability to his or her estate.

In order to avoid having one's estate pay unnecessary estate taxes, an "Irrevocable Life Insurance Trust", commonly known as an "ILIT" (pronounced "eyelet"), should be considered.

An ILIT is an irrevocable trust, which means that once it established, it cannot be undone (revoked). It must be established for the benefit of someone other than the trustor (the person creating it) or the trustor's spouse. Most often, the trustor's children are named as beneficiaries. During the trustor's lifetime, regular contributions may be made to the ILIT. The contributions will be used to pay for the life insurance policy which is owned by the trust. If structured properly, these contributions will be treated as gifts, but will not be subject to Gift Tax. Upon the trustor's death, the ILIT will be paid to the named beneficiaries, but will not be subject to any estate tax!


*The available estate tax exemption in 2009 is $3.5M. However, this exemption is currently scheduled to revert to $1M in 2011.