When dealing with planning the next steps for a business if the unexpected were to occur, it is important to consider implementing a buy-sell agreement so there is something in place in the event the owner of the business dies or leaves. A buy and sell agreement, also known as a “buy-sell agreement”, “buyout agreement” or simply a BSA, is used by various actors to divide the business in question. There are different ways to execute a BSA depending on the wishes of the individual.
- Under an Entity BSA, the business entity itself agrees to purchase the interest of a business owner.
- Conversely, under a Cross-Purchase BSA, the business owners agree to purchase one another’s interests.
- The Wait-And-See BSA gives the entity a first option to purchase the interest before the remaining business owner(s).
In addition to these three general formats, a One-Way BSA may be used when there is one business owner and the purchaser is a third party. The selection of the appropriate BSA format is critical for a variety of tax and non-tax reasons beyond the scope of this discussion. However, no BSA is complete without a proper funding plan. Like a beautiful automobile without fuel in the tank, a BSA without cash to fund the purchase is going nowhere.
Funding a Buy-Sell Agreement
Some common options to fund the purchase obligation under a BSA include the use of personal funds, creating a sinking fund in the business itself, borrowing funds, installment payments and insurance. Of these options, only the insured option can guarantee complete financing of the purchase from the beginning. Accordingly, a proper BSA will include both disability “buy-out” insurance and life insurance. Since the health of the business owner determines their insurability, any delay in acquiring appropriate coverage could be fatal to the success of the BSA and, with it, the survival of the business itself. This is where Profit Law Firm, LLC comes in to fight for the success of the business and business owner.
The Business Buy-Sell Agreement (BSA)
A BSA is a lifetime contract providing for the transfer of a business interest upon the occurrence of one or more triggering events as defined in the contract itself. For example, common triggering events include the retirement, disability or death of the business owner. An interest in any form of business entity can be transferred under a BSA, including a corporation, a partnership or a limited liability company.
A BSA is effective whether the business has one owner or multiple owners. As a contract, a BSA is binding on third parties such as the estate representatives and heirs of the business owner. This feature can be invaluable when the business owner wants to ensure a smooth transition of complete control and ownership to the party that will keep the business going. Subject to certain Family Attribution Rules (under Internal Revenue Code § 318), a BSA can help establish a value for the business that is binding on the IRS for federal estate tax purposes as provided (under Internal Revenue Code § 2703).
Entity Buy-Sell, Cross-Purchase Buy-Sell
and Wait-and-See Buy-Sell Agreements
A BSA is commonly structured in one of three general formats: An Entity BSA, a Cross-Purchase BSA or as a Wait-and-See Buy-See.
Entity Purchase Agreement:
- With this type of BSA, the buyer is the business and the the business owners sell back into the business. This likely occurs if the business owner becomes disabled or retires and wants to sell their ownership interest back. This agreement is also required if the business owner is to die.
Cross- Purchase Agreement:
- This type of BSA does not require the business to be involved and just involves the co-owners of the business to purchase the business interest of the owner who wishes to sell for whatever reason.
- When business owners seek more flexibility than other agreements might be able to offer, a wait-and-see agreement is possible. By allowing the delay of an entity plan until the actual incident such as death, disability or retirement, the company has the first option to buy back the company. This type of agreement typically use life insurance as a base of its plan.
An attorney at Profit Law Firm can help your business decide what type of agreements are necessary to secure the value you have worked so hard to build.