When a business owner dies, the business often dies too. Not because anything was done wrong, but no planning was done and that is wrong!
For a small business with multiple owners, business succession planning means the creation of a formal understanding among the business partners as to how each owner’s interest in the business will be transferred in the event of their separation from the business. Separation can result from a death, permanent disability, divorce, bankruptcy or even an estrangement from the other partners.
A buy-sell agreement is a legal document that binds the owners of a business to sell their interest to their partner(s) in the future. The buy-sell agreement guarantees a buyer, which is particularly important for a minority owner because the likelihood that a capable heir or third-party would have an interest in a minority stake of a family business is low. Likewise, an incumbent owner should select their business partner, not inherit them.
A good buy-sell agreement includes a methodology to value the business to determine the sales price between partners. As long as the formula is reasonable, the valuation is binding for tax purposes.
How to fund the buy-out is another important planning consideration. Life and disability insurance can provide an inexpensive source cash to finance the purchase. Ownership of the insurance policies must be planned because it can have unintended tax consequences for the acquiring owner.
We instruct clients without a will to run (not walk) to an attorney to execute this important document. We impart the same advice to our business clients who do not have a buy-sell agreement. This key document can ensure a smooth succession of your business to the next generation of ownership and avoid disharmony among the owners and their family.
