Protecting Business Owners and Preserving Businesses for Future Generations
BASICS OF BUY-SELL PLANNING
A buy-sell arrangement (or “business continuation arrangement”) is an arrangement for the disposition of a business interest upon a specific triggering event such as an owner’s death, disability, retirement, or other termination. Buy-sell arrangements should be considered in every closely held business. A well-drafted and properly funded buy-sell arrangement can protect the interests of the business owners and help facilitate the continuation of the business after the death, disability, or retirement of its current owners. Buy-sell arrangements take different forms including: (1) entity purchase or stock redemption, (2) cross-purchase, and (3) wait and see. The “best” type of arrangement depends upon several factors, including the type of business structure and the number of owners. This Sales Strategy will describe the primary types of arrangements, popular methods of funding arrangements, and other important considerations when contemplating a buy-sell arrangement.
BENEFITS OF BUY-SELL ARRANGEMENTS
Guarantee a Buyer. A buy-sell arrangement benefits the selling owner’s family by providing a guaranteed buyer(s). The remaining owners are protected against the sale of a significant (or, worse yet, majority) interest to an outside investor.
Create Liquidity. Upon a business owner’s death, retirement, or disability, his or her family has a continuing need for cash to
pay ordinary living expenses as well as any estate tax liability. Estate taxes are typically due nine months after the date of death. Selling a business under these circumstances usually results in the family receiving less than the fair market value.
Set a Fair Selling Price. A business valuation strategy that is determined while all owners are active can usually be negotiated on an arm’s-length basis. Once a business owner has left the business, negotiating a fair sales price is much more difficult for the owner (or the owner’s estate) because the remaining owners hold most of the cards.
Fix Value. A buy-sell arrangement negotiated at arm’s length ordinarily determines the valuation for estate tax purposes. This allows the owners to plan their estates and can reduce the risk of costly valuation disputes among business owners or upon estate tax audit.
Maintain Harmony. Because of the pressures of business ownership and everyday life, it is often difficult for owners of a closely- held business to maintain friendships and camaraderie. Maintaining harmony becomes more difficult after the family (spouse and/or children) of a deceased owner enters the business. A buy-sell arrangement can protect the owners and the business from problems that arise when a deceased owner’s family joins the business.