Today I will discuss part one of a three part mini-series in regards to How Business Owners can benefit from several BUY OUT options.
A buy-sell agreement is a legally binding document signed by owners of property (typically a business) placing certain restrictions on the transfer of property and requiring specified actions upon specified events. In its most common form, a buy-sell will require surviving owners to buy and the estate of a deceased owner to sell his or her business or real estate interest.
Aside from death, other typical purchase-triggering events include retirement, disability, bankruptcy, loss of professional license, divorce and voluntary termination of employment. If any of these triggers are an immediate concern, please reach out to one of our Wealth Advisors at Prosperity Wealth Advisors who specialize in working with business owners.
ADVANTAGES OF A BUY-SELL AGREEMENT
- A properly arranged buy-sell agreement protects business and remaining owners from inactive, uninformed, and potentially dissident shareholders and helps consolidate control in the hands of the agreed upon group. It also keeps ownership out of the hands of unexpected outsiders such as a co-owner’s creditor, a trustee in bankruptcy or ex-spouse.
- Active owner-workers can be sure that their incomes from the active business will be commensurate with their increased responsibilities and workloads, and their efforts will not go to someone who adds no value to the business.
- A buy-sell agreement will help fix the value of each owner’s business interest. It can also help avoid costly, time consuming, and aggravating litigation with both other owners and the IRS.
- A binding agreement between the owners provides a market at a reasonable and fair price for what otherwise might be an unmarketable interest. To the extent the agreement is properly funded, estate liquidity problems created by the inclusion of the business in the gross estate are eliminated.
- From the viewpoint of the heirs of a deceased business owner, a buy-sell severs their dependency on the surviving owners and the economic fortunes of a business that has lost a key person.
DISADVANTAGES OF A BUY-SELL AGREEMENT
- The agreement is useful only to the extent adequately funded on the date of the “triggering event.”
- The agreement must meet the requirements of complex tax and other laws, and thus it may be complicated and expensive to have drafted.
- A buy-sell agreement is only as good as the price (preferably price setting formula) is fair to all parties. This means such agreements must be revisited and thoroughly reviewed at least every three years.
WHEN THE BUY-OUT TAKES PLACE
No one knows whether the buy-out will occur:
- At a voluntary withdrawal of an owner prior to retirement
- At normal retirement age, as planned
- The owner has become disabled and can no longer work
- An owner can no longer contribute capital as required
- Because the owner has died or is terminally ill
- The owner’s stock would be involuntarily transferred (such as to a creditor or ex-spouse)
What is certain is that one of these events will occur!
So ideally, the buyer’s obligation will be funded in a manner that is easy for the parties to understand, is low cost, is easily administered, and will not adversely affecting the working capital or credit position of the business or professional practice.
The following is an example showing five lives and the chances that one will not survive to age 60:
PROBABILITY OF AT LEAST ONE FROM A GROUP OF 5 PEOPLE DYING BEFORE AGE 60
Individual’s Age Sex
Probability Of Dying Before 60
Probability of any of five People Dying Before Each Reach 60
Source: Ohio Department of Insurance Office of Communications
The probability of a long term disability among the five participants is even greater. Therefore, death and disability must be considered major business interruption possibilities.
Quite often, a business dies the same day its owner dies.
There are four major practical alternatives to meet the need for funds to buy out a co-owner: cash, borrowing, installment payouts, and life insurance. Let us briefly examine the impact of each solution.