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Buy-Sell Agreements – Valuable Tool for Closely Held Business Transitions
Co-owners of a closely held business work together to build a successful, valuable business, but give little thought to protecting that value in the event of an unanticipated exit of one co-owner whose interest needs to be purchased or redeemed. Buy-sell agreements are one of the most important and most often overlooked devices in estate planning and business succession. These contracts restrict a business owner, or co-owner, from freely transferring their ownership interest in a closely held business. A properly drafted and implemented buy/sell contract funded with life insurance protects disruption in the event of among others, the death, disability or retirement of the owner or a co-owner. It provides for an orderly transfer of the business within the family ensuring the business stay within the core family and continues uninterrupted. The liquidity to affect the required transfer can be provided either by cash in the business or with life insurance. The use of life insurance is the most common method.
The availability of life insurance is especially important in the family owned business setting where some members are involved in the family business, and others are not. In this instance, life insurance is used to compensate the noninvolved family members while allowing the involved family member to continue to operate and grow the business independently. If the exiting owner is a non-family co-owner, life insurance provides the funding for the surviving owner to purchase the interest of the exiting owner.
Buy/sell agreements come in two basic flavors. One is the redemption form under which the business purchases the ownership interest of the exiting co-owner and pays for the required life insurance policy. The other is a cross-purchase form where each co-owner agrees to buy the shares of the exiting co-owner and each co-owner shares in the cost of the required life insurance. Important tax differences exist between the two forms.
In both instances, a key provision is a method of determining the valuation of the existing owner's interest. Various methods are employed. The best approach is an independent appraisal at the time of the triggering event. This method assures that he exiting-owner or the related estate receive fair market value.
Make time to speak to an estate-planning attorney about this important topic.