The Buy-sell Agreement: Alternative Forms
| Publication year | 1993 |
| Pages | 2381 |
| Citation | Vol. 22 No. 11 Pg. 2381 |
1993, November, Pg. 2381. The Buy-Sell Agreement: Alternative Forms
Unless there is a funded buy-sell agreement in place at the time of a triggering event, the continuing business owners may find themselves in business with the heirs of the deceased owner or may be forced to sell the business to compensate the departed owner or his or her heirs. In the case of a sole proprietorship or closely held corporation, there may not be a ready market for the business, leaving the heirs with an essentially valueless entity or the retiring or disabled owner with no source of income.
This article provides an overview of buy-sell agreements and discusses several varieties of such an agreement. A means to fund the buy-sell agreement must be established, and the business must be accurately valued to support the terms of the contract.
To be effective, buy-sell agreements must include a means to ensure that funds are available to comply with the terms of the contract. There are two primary ways to fund obligations: a "sinking fund" to which regular contributions are made by each owner, or some form of life insurance covering the owners.
A sinking fund is viable only if the owners have access to sufficient cash on an ongoing basis to ensure that money is available to meet the buy-sell contract terms. In most cases, this approach either ties up too much capital or the cash simply is not available.
Life insurance is available in many forms and generally can be obtained at a cost acceptable to most business owners. The variations available include term, convertible term, universal, variable universal, whole life, first-to-die and second-to-die life insurance. Because the costs and features vary widely among policy types, it is essential to analyze both the business needs of the company and the features of each insurance plan.
There are several elements necessary to a buy-sell agreement. The contract may ensure that a transfer of ownership will occur as planned. However, unless there is a sinking fund or life insurance in place, there is no means to fund the obligation.
The four major types of buy-sell agreements are: "one-way" agreements, cross-purchase agreements, entity (or stock) redemption agreements and "wait and see" agreements. There are diverse tax, legal and funding implications associated with each of these agreements. The heirs of the deceased owner, or the departing owner in the case of retirement or disability, also must agree to and comply with the terms of the buy-sell agreement.
A one-way agreement enables a third party to acquire a deceased or departing owner's interest in the business. This agreement is usually used to provide a market for a closely held corporation or individual ownership interest. In many cases, the third parties are key employees.
This type of buy-sell agreement is simple to fund. The third party can either establish a fund for the...
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