December 2, 2006 / Publications
Business Succession Agreements
By Louis A. Reisman
If you own any part of a closely-held business, you should be considering a business succession agreement (often referred to as “buy-sell” agreement) to provide for the disposition of that interest under various circumstances. These agreements can provide for an orderly transfer of a business interest on the owner’s death, disability or retirement in order to avoid forced liquidation of the business. More importantly, these agreements can help assure your heirs of receiving a fair price for your valuable interest.
Although these agreements usually are used when there are several co-owners, even if you own 100% of a business, you can provide a market for that business by using a buy-sell agreement to transfer ownership to key employees and to provide funds for the payment of estate taxes or other expenses. When there are other co-owners, buy-sell agreements can help prevent the sale to outsiders of partial business interests and can eliminate disputes about the valuation of those interests.
If there are several co-owners, the purchase under the buy-sell agreement may be made either by the other co-owners (a “cross purchase agreement”) or by the business itself (a “redemption” agreement). The choice between a cross purchase agreement and a redemption agreement depends on the type of business entity and the source of funds which will be used to provide the payment of the purchase price.
Many business succession agreements provide that insurance will be utilized to pay all or a portion of the purchase price. Any purchase price which is not paid by insurance can be payable immediately or is often spread over a period of years, with appropriate security being given for the unpaid balance. The longer the period of deferred payments, the more consideration which must be given to the property which ultimately will secure the payment of the purchase price.
If the business is incorporated and life insurance is used, there are certain income tax advantages to a cross purchase agreement. For example, if the surviving owner directly purchases the interest of the deceased owner, the surviving owner’s combined income tax basis for his stock in the corporation will include the price paid for the deceased owner’s stock. On the other hand, a redemption agreement can be simpler to administer when there is life insurance involved, so the determination of the type of agreement requires careful consideration.
The typical buy-sell agreement will specify the events, which trigger a buy-out and ordinarily will provide for a specific price or a method for determining the price. That method can involve advance agreement by the co-owners, the application of a formula or a determination by an outside independent appraisal at the time the buy-out event occurs. Each of these methods can result in significant differences in the purchase price for the business interest. Therefore, it is essential that all relevant factors be carefully considered to ensure the continued success of the business and to assure your heirs of a fair price for your share of the business.
Buy-sell agreements have important estate tax and income tax consequences which require the involvement of your accountant, life insurance agent and attorney in planning for the succession of business interests and the design and implementation of the proper buy-sell agreement. We would be happy to assist you with these matters and we invite you to call us with any questions you might have about this important part of your financial and estate planning.