As a small-business owner, you have a lot invested in your company. Like most entrepreneurs, your business is more than just another valuable asset; not only is it likely to be the primary source of your family's income, it is also a labor of love. For these reasons, it is crucial to plan for the future of your business using a carefully considered succession plan. Executing a buy-sell agreement could be one strategy for managing your transition. This agreement, when properly structured and funded, sets forth a strategy for managing the unexpected and could increase the likelihood that your company will survive your absence.
Understanding Buy-Sell Agreements
A buy-sell agreement is a written arrangement that facilitates the sale of your business interest if you die or become disabled. The business, or your co-owner if you have one, agrees to buy your interest. In return, you agree to sell. You, or your heirs, will receive payment for your share of the company without the aggravation and delay of trying to sell the business on the open market. This arrangement offers a number of benefits to all parties involved. Specifically, the agreement allows you to:
? Specify the company's value
? Determine the conditions for an eventual sale
? Identify buyers
? Choose a method for funding the sale
How Buy-Sell Agreements Work
Your buy-sell agreement will likely specify those events, such as death or disability that will lead to the sale of your interest. In addition, the agreement may also cover potential events such as, divorce and retirement. Your financial advisers can help you determine which events should be included in the agreement based on your personal circumstances.
Some additional aspects of the sale that are commonly addressed in buy/sell agreements include the following:
Valuation
You probably have a fairly accurate estimate of your company's value. To create a valid buy-sell agreement, however, you will need a professional valuation to determine how much your share of the business is worth. Because the company's value can fluctuate, you should consider updating the valuation at least every two years.
Buyers
Without a buy-sell agreement, you have little or no control over the disposition of a co-owner's interests. This situation can often raise difficult questions; for example, if your business partner dies, would you want to be in business with his or her spouse or children? The buy-sell agreement allows you and your partners to specify how ownership and control will be transferred if one of you cannot continue as a participating owner.
Funding
You or your business partner can choose from several methods to fund the purchase price set by the agreement. Businesses with ample reserves can make a cash payment. This method may work well for very small businesses, but it's often unrealistic for larger and more valuable companies. If the business has adequate cash flow, a sinking fund allows the accumulation of reserves over time. Still, it is impossible to predict when an owner could become disabled or die, and that means the sinking fund balance might be insufficient just when it's needed. Bank loans are another option, but it is important to understand that many financial institutions are hesitant to loan funds to a company whose owner has just left the business involuntarily.
For these and other reasons, insurance is often the most efficient method for funding a buy-sell agreement. The premiums are predictable and the benefits are guaranteed. The owners can arrange to sell their interest to the business, which is referred to as an entity plan, or they can agree to sell to each other, which is a cross-purchase plan.
In an entity plan, the business buys life insurance and disability income insurance on each owner. The business generally pays the premiums and is the policies' beneficiary. With a cross-purchase plan, each owner buys and is the beneficiary of the life insurance and disability income policies on the other owners. Your financial advisers can help you determine which plan and type of insurance coverage is appropriate for your needs.
Is a Buy-Sell Agreement Right for You?
Transferring ownership of a family business in a way that provides for an orderly and fairly priced sale is a challenge under the best of circumstances. However, this much is certain: a failure to plan for unexpected transitions risks disrupting the business, and it increases the likelihood that your business could cause financial hardship for its owners, or worse, the business could fail.
As with any aspect of your finances, putting a plan in place is the best protection against the unexpected. A properly funded buy-sell agreement may provide exactly the mechanism you need for an efficient transfer as well as the cash required for any payments to the selling party. Perhaps the most important benefit, though, is the peace of mind that results from knowing that your family and your business are protected.
For questions, please call Thomas Reddick at (760) 602-3539.
This article is base, in whole or in part, on information provided by the Planning Services Department of Smith Barney. IRS Circular Disclosure: Citigroup, Inc., its affiliates, and its employees are not in the business of providing tax or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties. Tax-related statements, if any, may have been written in connection with the "promotion or marketing" of the transaction(s) or matter(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.
Understanding Buy-Sell Agreements
A buy-sell agreement is a written arrangement that facilitates the sale of your business interest if you die or become disabled. The business, or your co-owner if you have one, agrees to buy your interest. In return, you agree to sell. You, or your heirs, will receive payment for your share of the company without the aggravation and delay of trying to sell the business on the open market. This arrangement offers a number of benefits to all parties involved. Specifically, the agreement allows you to:
? Specify the company's value
? Determine the conditions for an eventual sale
? Identify buyers
? Choose a method for funding the sale
How Buy-Sell Agreements Work
Your buy-sell agreement will likely specify those events, such as death or disability that will lead to the sale of your interest. In addition, the agreement may also cover potential events such as, divorce and retirement. Your financial advisers can help you determine which events should be included in the agreement based on your personal circumstances.
Some additional aspects of the sale that are commonly addressed in buy/sell agreements include the following:
Valuation
You probably have a fairly accurate estimate of your company's value. To create a valid buy-sell agreement, however, you will need a professional valuation to determine how much your share of the business is worth. Because the company's value can fluctuate, you should consider updating the valuation at least every two years.
Buyers
Without a buy-sell agreement, you have little or no control over the disposition of a co-owner's interests. This situation can often raise difficult questions; for example, if your business partner dies, would you want to be in business with his or her spouse or children? The buy-sell agreement allows you and your partners to specify how ownership and control will be transferred if one of you cannot continue as a participating owner.
Funding
You or your business partner can choose from several methods to fund the purchase price set by the agreement. Businesses with ample reserves can make a cash payment. This method may work well for very small businesses, but it's often unrealistic for larger and more valuable companies. If the business has adequate cash flow, a sinking fund allows the accumulation of reserves over time. Still, it is impossible to predict when an owner could become disabled or die, and that means the sinking fund balance might be insufficient just when it's needed. Bank loans are another option, but it is important to understand that many financial institutions are hesitant to loan funds to a company whose owner has just left the business involuntarily.
For these and other reasons, insurance is often the most efficient method for funding a buy-sell agreement. The premiums are predictable and the benefits are guaranteed. The owners can arrange to sell their interest to the business, which is referred to as an entity plan, or they can agree to sell to each other, which is a cross-purchase plan.
In an entity plan, the business buys life insurance and disability income insurance on each owner. The business generally pays the premiums and is the policies' beneficiary. With a cross-purchase plan, each owner buys and is the beneficiary of the life insurance and disability income policies on the other owners. Your financial advisers can help you determine which plan and type of insurance coverage is appropriate for your needs.
Is a Buy-Sell Agreement Right for You?
Transferring ownership of a family business in a way that provides for an orderly and fairly priced sale is a challenge under the best of circumstances. However, this much is certain: a failure to plan for unexpected transitions risks disrupting the business, and it increases the likelihood that your business could cause financial hardship for its owners, or worse, the business could fail.
As with any aspect of your finances, putting a plan in place is the best protection against the unexpected. A properly funded buy-sell agreement may provide exactly the mechanism you need for an efficient transfer as well as the cash required for any payments to the selling party. Perhaps the most important benefit, though, is the peace of mind that results from knowing that your family and your business are protected.
For questions, please call Thomas Reddick at (760) 602-3539.
This article is base, in whole or in part, on information provided by the Planning Services Department of Smith Barney. IRS Circular Disclosure: Citigroup, Inc., its affiliates, and its employees are not in the business of providing tax or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties. Tax-related statements, if any, may have been written in connection with the "promotion or marketing" of the transaction(s) or matter(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.