What do you want for your business when you're gone?
You’re an entrepreneur. You’ve built or have become a part of an organization you’ve poured yourself into. If you are no longer able to run the business, who do you want to take over, if anyone, and how? We can help you craft a strategy.
St. Charles Business Succession Lawyer
There are a number of ways to craft an incapacity and succession strategy for your small business. However, the most common is through the use of buy-out or buy-sell agreements drafted into either the operating documents of the entity itself or into a separate buy-sell agreement between the owners of the business. Often, these buy-sell agreements are provided with liquidity through life insurance.
What is a buy-sell agreement?
A buy-sell agreement is, in general terms, is an agreement among owners of a closely held business that is designed to restrict the rights of owners to transfer their interests in the entity. It will also typically provide the owners of the entity the right (and sometimes the obligation) to purchase the interests of an owner when the owner dies, becomes incapacitated or permanently disabled, quits or is fired, or otherwise wishes to make a lifetime transfer of his or her interest.
A buy-sell agreement will also generally provide for the valuation of the owner’s interest either through some formula or through appraisal of the interest. If a formula is used, it is important to review the agreement periodically to determine if the business is still being properly valued.
Using life insurance to fund a buy-sell agreement.
A buy-sell agreement does not require a funding mechanism to be valid. If the entity and/or its owners have enough free resources to afford to buy out the relevant interests, then no additional funding is necessary. However, often the other owners or designated employees either do not want to or cannot afford to pay cash or the payments on a note for the deceased owner’s interest. In such circumstances, life insurance purchased in advance either by the entity or by the owners themselves is often used to fund the transaction.
When the business itself purchases the insurance and is the beneficiary of the insurance, this is known as a “redemption” agreement. When the other owners purchase the insurance on each others’ lives, this is known as a “cross-purchase” agreement. Both have pros and cons from a tax and non-tax perspective. In more advanced strategies, an insurance LLC can also be incorporated to try to gain the advantages of both a redemption and cross-purchase agreement without the drawbacks of either.
What is a buy-sell agreement?
A buy-sell agreement is, in general terms, is an agreement among owners of a closely held business that is designed to restrict the rights of owners to transfer their interests in the entity. It will also typically provide the owners of the entity the right (and sometimes the obligation) to purchase the interests of an owner when the owner dies, becomes incapacitated or permanently disabled, quits or is fired, or otherwise wishes to make a lifetime transfer of his or her interest.
A buy-sell agreement will also generally provide for the valuation of the owner’s interest either through some formula or through appraisal of the interest. If a formula is used, it is important to review the agreement periodically to determine if the business is still being properly valued.
Using life insurance to fund a buy-sell agreement.
A buy-sell agreement does not require a funding mechanism to be valid. If the entity and/or its owners have enough free resources to afford to buy out the relevant interests, then no additional funding is necessary. However, often the other owners or designated employees either do not want to or cannot afford to pay cash or the payments on a note for the deceased owner’s interest. In such circumstances, life insurance purchased in advance either by the entity or by the owners themselves is often used to fund the transaction.
When the business itself purchases the insurance and is the beneficiary of the insurance, this is known as a “redemption” agreement. When the other owners purchase the insurance on each others’ lives, this is known as a “cross-purchase” agreement. Both have pros and cons from a tax and non-tax perspective. In more advanced strategies, an insurance LLC can also be incorporated to try to gain the advantages of both a redemption and cross-purchase agreement without the drawbacks of either.
Start working with a St. Charles Business Succession Lawyer today.
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