Gregory S. DuPont
A “Curtain Call” for Your Company?
Have you ever wondered what would happen to your company if you if you could not continue to personally run it? Would your family simply sell your company? To whom would your family sell it? And if a buyer existed, what if he or she did not have sufficient cash to make the purchase? This is where having a buy-sell agreement, can play the help solidify the future of your business.
A buy-sell agreement is a legal contract that guarantees a buyer for your business, and provides a means of funding the purchase. You typically negotiate a buy-sell agreement with partners, shareholders, your management team, or any key employees who may have an interest in the future ownership of your company. The price is agreed upon up-front, when the deal is struck. And, more often than not, life insurance plays the “supporting role” by funding the agreement.
Setting the Stage for Success
Okay, now that you’ve realized the importance of a buy-sell agreement, you may be wondering, “So, what next?” Well, there are generally two types of buy-sell agreements you can choose from—the cross-purchase and the entity purchase. Under a cross-purchase, you directly make an agreement with another partner or shareholder. If either one of you were to die, the surviving partner would purchase the deceased partner’s shares. Usually, you’ll own a life insurance policy on the life of your partner (and vice versa) that will fund the future purchase. If you have several partners, you would have an agreement with each partner. Likewise, each partner would also have an agreement with all other partners.
Overall, a cross-purchase is an ideal mechanism if your company has only two or three owners. However, when additional owners are involved, the logistics of multiple agreements and life insurance policies can be rather complex, administratively tedious, and somewhat costly. That’s where an entity purchase agreement enters the scene.
Under an entity purchase, your company (not you) makes an agreement with all shareholders and also purchases a life insurance policy on each shareholder as well. Naturally, this eliminates the administrative hassle of managing multiple agreements and life insurance policies, which is inherent to a cross-purchase agreement. Bear in mind, since the company owns the policies, any cash value attributable to each policy may be vulnerable to corporate creditors.
Tax Issues Play a Part, Too
One benefit of the cross-purchase agreement is that when one owner dies, the surviving owner(s) receives a step-up in basis for any newly acquired shares—that is, future capital gains for the newly acquired shares will be based on the purchase price spelled out in the agreement, not on the original basis of the deceased owner. The end result will be lower capital gains taxes should the newly acquired shares be sold or transferred at a future time.
Under an entity purchase, shareholders will not receive a step-up in basis. That’s because any existing shares will increase in value (due to the agreement being made with the company rather than each individual shareholder). Therefore, you’ll need to decide whether the potential tax advantages of the cross-purchase agreement exceed the logistical benefits of the entity purchase agreement.
The Grand Finale
Clearly, a buy-sell agreement is not simple to implement. Therefore, it will require the assistance of qualified insurance, legal, and tax professionals. However, the benefits of such an agreement clearly outweigh the administrative and legal costs of implementing the agreement, and are no comparison to not having an agreement at all. In the end, a buy-sell agreement will ensure that your family, and those who depend on your business, will continue to benefit from the legacy of your business.