As a successful business owner, you're probably no stranger to working hard to achieve your goals; and by now, your business has probably become one of your most valuable assets. However, have you considered what would happen to your business and family should you unexpectedly die or become disabled? These are some of the questions you should be asking yourself and then making the proper arrangements for:
- Will any of your heirs or survivors have the necessary experience to operate your business on a day-to-day basis?
- Will they be forced to sell the business?
- If they must sell, will they receive a fair market value for your business or their share?
- Would the IRS possibly seek a higher valuation for your business?
- Do you want to provide your surviving heirs with options?
Through proper planning, these questions can be answered and handled with much or ease. Ultimately, a Buy-Sell Agreement is the most common and correct solution.
Protecting Your Family (and Your Business) With a Buy-Sell Agreement
When examining different strategies such as the Buy-Sell Agreement, it is important to select one that ensures a smooth transition of ownership and protects your family's financial future. A Buy-Sell Agreement can and will help you accomplish this goal. Simply stated, it is a contract among business owners. At the loss of an owner whether due to death or another reason, the business interest is transferred according to the terms outlined within this contract. The other owner(s) are obligated to purchase the deceased's interest and the deceased's heirs are obligated to sell.
Buy-Sell Agreements funded by life insurance are also useful in situations other than the instance of a death or disability. Sometimes, business partner just simply must go their separate ways to pursue other paths in life. When circumstances require the owners of a business to execute a previously arranged buy-sell agreement, sufficient cash may not be available to the entity, or to its owners, to make it feasible for the purchase of a withdrawing owner's interest. Usually, if the owners and/or the entity, as the case may be, are unwilling or unable to make the purchase, the buy-sell agreement provides that the withdrawing owner is free to sell his interest to an outsider. For this reason, life insurance, on the withdrawing owner's life, is frequently used to the finance the purchase of the interest.
Always remember...there are various options available when it comes to buy-sell agreements, as well as the manner in which to fund them. However, business insurance, specifically business life insurance is the smartest choice.
Option 1: Wait...and Hopefully The Cash is There...
In this option, the surviving owner(s) use cash at the death of a co-owner to fund the buy-sell agreement, however, several drawbacks to this method exist.
- At death, the funds may just not be available for payment.
- A savings plan accumulates funds over time, which means they may not be available when necessary. What would happen if the funds were needed tomorrow?
- Sometimes a savings plan will be depleted for other unforeseen expenses.
- The accumulation of cash may ultimately bring about an accumulated earnings tax problem.
Option 2: Wait...and Hopefully Borrow Funds...
In this option, at the death of a co-owner, surviving owner(s) attempt to borrow funds, usually in the form of bank loans. Again, much like the first option, this method has drawbacks.
- The future growth of the company may not be slowed due to the increased expense of loan repayment.
- The death of an owner could always cause sales to decline; often, customers place value on the owners of a company.
- Sometimes, the death of an owner may make it difficult to even receive a loan.
- A surviving owner may have to sign personally for funds thus exposing personal assets.
- Surviving owners pay dollar for dollar plus interest for the deceased's outstanding share of the business.
Option 3: Insurance - THE SIMPLE & SMART CHOICE
Purchasing insurance can be the most cost effective funding option for a buy-sell agreement. Using insurance as the vehicle to fund the buy-sell agreement will provide many benefits, including:
- The immediate availability of proceeds when a death or disability occurs.
- The funds used to buy the deceased's share are purchased for pennies on the dollar.
- Death benefit proceeds are generally income tax free.
- Premiums may be significantly lower than the cost of repaying the loan interest.
The Types of Buy-Sell Plans Available
Remember, a Buy-Sell Agreement will help accomplish the following:
- Creates a market for the stock.
- Sets a predetermined price at which owners agree to buy and sell their shares.
- Provides the money needed to fund the plan.
- Helps to ensure your business will continue as planned.
- Ensures the proper arrangements for the security of your heirs or survivors.
Cross Purchase Plan
With a cross purchase plan, owners enter into an agreement to take out life insurance polices on each other's lives. To fund this plan, each owner applies for, owns, and pays the life insurance premiums on the other owners. Each stockholder owns is also the beneficiary of the life insurance death benefit. The corporation is not a party to the agreement. The surviving stockholders purchase the interest of the deceased stockholder as individuals from the estate of the deceased stockholder.
In the event that an owner dies...
- Life insurance proceeds are paid to the surviving owner(s) income tax free.
- Proceeds are used to purchase the heirs' business interest.
- Heirs receive an agreed-upon payment for their business interest.
- Surviving owner(s) receive an increased cost basis for the acquired business interest.
In this plan, the owners enter into an agreement with the business. The corporation, rather than the stockholders, purchases the insurance policy, pays the insurance premiums and is the beneficiary on the lives of each shareholder. The amount of insurance on each stockholder is usually equal to the proportionate share of the purchase price. Upon the death of one of the stockholders, the death benefits are paid to the corporation who then buys the deceasedís stock from the deceasedís estate. Premiums are not taxed deductible, however the proceeds are received income tax free.
In the event that an owner dies...
- The business will receive the life insurance proceeds.
- The business uses the proceeds to purchase the deceased's business interest.
- Heirs receive an agreed-upon price for their business interest.
Stock Redemption Plan
A stock redemption plan is an agreement between the business and its shareholders. The corporation applies for, owns, and pays the life insurance premiums on each shareholder.
When a shareholder passes...
- The corporation will receive the life insurance proceeds.
- The corporation will use the proceeds to purchase the shareholder's outstanding stock.
- Heirs receive an agreed-upon price for the shareholder's outstanding stock.
The Wait & See Plan
A "Wait & See" Plan combines some of the advantages of both a Cross Purchase Plan and an Entity Plan adding for new levels of flexibility.
Some of the basics include:
- The owner and the company form an agreement.
- The surviving owners/company have the option to purchase the deceased's business interest.
- If the option is not exercised, the other party is obligated to purchase the interest.
- Funding the agreement is usually the obligation of the party who has the first option.
- If necessary, loans between the two can be used to help a party who is underfunded.