How can a buy-sell agreement help a business owner?
Buy-sell agreements are one of the most efficient means of transferring your business interest. They are used primarily to ensure a smooth continuation of a business after a potentially disruptive event, such as an owner’s retirement, incapacity or death.
A buy-sell agreement is a valuable planning tool that can provide for the orderly succession of a family business. Proper funding of the agreement can provide liquidity when it is most needed—during disability or retirement, or at death. Further, a buy-sell agreement will establish the purchase price of an owner’s business interest, avoiding potentially expensive and time-consuming delays due to disagreements over value, and possibly helping to establish a value for estate-tax purposes at death.
A typical buy-sell agreement allows the business entity itself or other business owners the opportunity to purchase a departing owner’s business interest at a predetermined price, or pursuant to a determined formula. This allows the business and the remaining owners to protect themselves from future adverse consequences, such as a disruption of operations, an entity dissolution or a business liquidation, which might result if certain events, such as an owner’s sudden incapacity or death, should occur. The agreement can also reduce the possibility that the business will fall into the hands of outsiders.
The ability to fix the purchase price of a business interest makes this tool especially useful in estate planning. An agreement on a purchase price while all parties are alive reduces the possibility of unfair treatment to a deceased owner’s family members. It also provides certainty that upon an owner’s retirement, he or she will receive the agreed upon value in exchange for the business interests, which may then be used for retirement liquidity needs.
Without a funding plan in place, the buyer(s) may be forced to sell assets, take out loans or even file for bankruptcy.
Because funding for buy-sell agreements is typically arranged when the buy-sell agreement is executed, both the placement of additional financial strain on the business and the possibility that funds will not be available when needed are reduced, ensuring that the owner receives a set price, resulting in liquidity for the owner or the owner’s estate.
For a buy-sell agreement to be successful, the parties should arrange for proper funding to carry out the terms of the agreement. Without a funding plan in place, the buyer(s) may be forced to sell assets, take out loans or even file for bankruptcy. There are several ways to fund a buy-sell agreement and several factors that may influence the choice of the funding method. Funding methods include: cash, borrowing, installment sale and insurance.
Insurance is generally the most cost-efficient way to fund a buy-sell agreement. It is the funding element that makes carrying out the requirements of the agreement possible, by providing the necessary funds just when they are needed. It obligates the money for the stated purpose, thus assuring its availability to implement the terms of the agreement.
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Shawn P. Landau is a Financial Advisor with the Wealth Management division of Morgan Stanley in New York City. The views expressed herein are those of the authors and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member SIPC (http://www.sipc.org). Morgan Stanley Financial Advisors engaged Worth to feature this article. Landau may only transact business in states where he is registered or excluded or exempted from registration. (http://www.morganstanleyfa.com/ggmgroup) Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Landau is not registered or excluded or exempt from registration. Morgan Stanley Smith Barney LLC offers insurance products in conjunction with its licensed insurance agency affiliates. Morgan Stanley and its Financial Advisors do not provide tax or legal advice. Individuals should seek advice based on their particular circumstances from an independent tax advisor. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the US. CRC1461435 04/16