Archive for July, 2010

If you are the owner of a small, closely held business, you probably are focusing on making your business profitable, and have not spent any time at all thinking about the future of your company when you are gone.  But that decision has to be made sooner rather than later.  Even the most successful of businesses face a serious challenge in surviving beyond the departure of its first generation of owners.

Failing to plan for the disposition of a business interest could be devastating to the family of the owner and to the business itself. Problems are many and can include:

• not finding a suitable buyer when the time comes, forcing the family to sell the business to outsiders or at drastically reduced prices;

• inexperienced family members taking helm of the business, causing friction with existing management or employees; and

• the subchapter S status of a corporation could be jeopardized if the stock goes to ineligible shareholders.

So, do you need a buy sell agreement?  A buy-sell agreement is simply a contract that spells out the disposition of the business by obligating one party to buy and obligating the departing owner to sell the business interest upon the triggering event. A well-drafted buy-sell agreement will serve to:

• provide a readily controlled market for the departing owner’s interest,

• establish a price or valuation method of the business interest in advance,

• provide for a smoother transition for the business,

• prevent unintended tax consequences, and

• provide cash to a disabled business owner or to the estate of a deceased owner.

After carefully considering whether a buy sell agreement is best for your circumstances, the next issue to determine is funding for such a transaction.  The buy-sell agreement should specify how the buyer will pay for the business interest. There are many ways to fund such future events including life insurance policies on the principals, savings or other investment accounts that can be used to tap into, and installment sales.

 

Installment sales are often part of a buy-sell agreement, for at least a portion of the purchase price. An installment sale will require payment of principal and interest from future business earnings, forcing the seller to rely upon the business’s success to receive payments. The uncertainty of installment sales makes them more appealing when used in conjunction with something like insurance funding.

Buy sell agreements are flexible enough that they can be structured to meet the needs of both the business and the owners, taking into consideration tax implications and individual goals for the transfer of the business. A buy-sell agreement is often structured in one of two ways: as an “entity purchase” or a “cross purchase” between the owners of the business.

Under the entity purchase method (aka the redemption method), the business contracts to purchase the interest of a departing, disabled, or deceased owner, and each owner promises to sell upon that triggering event. When combined with a life insurance policy, the business owns a policy on each owner, pays the premiums, and is the named beneficiary on the policy.  Upon the triggering event, the policy payout can be used to meet the terms of the agreement.

The cross-purchase method uses a contract between the owners, not the business entity itself. Each owner purchases a share of the departing owner’s business interest as detailed in the contract. If funded with insurance, each owner buys an insurance policy on the other owner, pays the premium and is the beneficiary.  At the death or disability of an owner, each co-owner receives policy benefits, which are then used to meet the terms of the agreement.

Are you a business owner in need of additional information on buy sell or other business agreements?  If so, please contact the Law Offices of Daniela Lungu at (925) 558-2710 or email info@lungulaw.com.

Do you want a specific topic discussed in this blog? If so, please contact us at info@lungulaw.com with your suggestions.

About Daniela Lungu, Attorney at Law

Daniela Lungu, founder of the Law Offices of Daniela Lungu, devotes her law practice to asset protection through estate and business planning. Ms. Lungu’s goal is to provide the people of the Bay Area and California with the highest quality, and most personalized legal services possible. Her attention to detail and a high level of communication with her clientele distinguish her from other attorneys in the field.


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