"Does Losing a
Partner Mean Losing His or Her Share of the Business?
Protect Your Business with a Buy-Sell Agreement"
By: AJ Sheek
There’s no delicate way to put it. If your business is set
up as a partnership or corporation, you may be concerned
about what would happen to your business if your partner(s)
or other owners became disabled or were to die. If a partner
becomes disabled, could he or she sell his or her share to
anyone, even if you didn’t agree with the choice? If that
partner dies, who is heir to his or her share of the
business?
Truth is, without a properly written agreement in place,
your partner’s share could pass into unwanted and
inexperienced hands. Likewise, if a partner becomes disabled
and wants to sell his or her share back to the business, or
if the owner dies, can you ensure that the business will
have enough liquidity to purchase that share?
There are steps you can take to assure that an heir to the
business is agreed upon now, or that you or the business can
buy your partner’s share should anything happen.
To assure that the business isn’t sold (in the case of a
partner’s disability) or willed (in the event of a partner’s
death) to an unwanted third party, the partners of the
business can set up what is known as a “Buy – Sell
Agreement.” The agreement can be constructed so that if a
partner becomes disabled and wants to sell his or her share,
the company or remaining partner(s) agree to purchase the
share, or an agreed-to third party agrees to purchase the
share.
Alternatively, the agreement can be set up so that if a
partner dies, the company or remaining partner(s) agree to
purchase their share, or the share can be bought by an
agreed-to third party, or willed to an agreed-to heir.
Simply stated, a Buy-Sell Agreement ensures a known
succession and continuation of the business, should anything
happen to one or more partners.
But a Buy-Sell Agreement needs the correct funding to be
effective; typically, funding comes from life* and
disability insurance policies. These policies can be used to
fund two types of Buy-Sell Agreements – Buy-Sell Cross
Purchase Agreements and Buy-Sell Entity Purchase Plans. Here
are examples of how these can work for you:
Buy-Sell Cross Purchase Agreement
Jane and John own a business together, so they set up an
agreement to sell their shares of the business to each other
in the case of their death or disability. To fund the
agreement, Jane owns a disability insurance policy on John
and uses the proceeds from that policy to purchase John’s
share of the business if John becomes disabled and wants to
sell his share. Additionally, Jane owns a life insurance
policy on John, so if he dies, she can use the proceeds to
purchase his share from the estate. Likewise, John owns
disability and life insurance policies on Jane. This method
of funding provides each partner with the proceeds to
purchase the company without having to liquidate a part of
the business.
Buy-Sell Entity Purchase Plan
Now, let’s say we have a corporation with four major
stock holders: Jane, John, Jack and Jill. For this scenario,
a Buy-Sell Entity Purchase Plan can be used. In this case,
the entity purchases disability and life insurance policies
on each stock holder. In the event of their deaths, the
business uses the proceeds from the life insurance policy to
buy back the deceased’s shares.
Despite their simple strategy, funding these agreements can
be tricky, and involves many variables, such as how much to
fund each policy, what types of policies are best to use,
what’s the actual value of your business, and each partner’s
share in it. It’s important to work with a team – you, your
financial planner, attorney, accountant, and business
appraisal expert – to determine the strategy and funding
that’s best for you, your partners, and your business. Don’t
wait for disaster to strike – agree what will be done
tomorrow, today!
Unless it qualifies for the small corporation exemption, a
corporation may be subject to corporate AMT, which may
affect the tax treatment of corporate owned life insurance
policies. Consult your tax advisor to determine the
applicability and potential effect of corporate AMT in your
own situation. Policy withdrawals and outstanding policy
loans (including any accrued interest) usually reduce the
death benefit payable under the policy.
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This article appears courtesy of AJ Sheek. AJ is a
Financial Planner with MetLife Securities, Inc. He
specializes in meeting the financial needs of
business owners in the Dallas/Fort Worth area. You
can reach AJ at the office at 972-447-1470.
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Investment Advisory Services Offered by:
MetLife Securities, Inc.
One Madison Avenue
New York, New York 10010
E0305BPBH(exp0605)MSI-LD
Metropolitan Life Insurance Company, New York, NY 10010
