Business Buy-Sell Directives
While this sounds more like a business issue than an estate planning concern, I can assure you that improper planning for business contingency will cause some of the biggest headaches in the settling of your estate.
All businesses should have a contingency plan in the event one of the key partners dies or becomes disabled. A continuity of business buy-sell agreement would provide a system to allow the business to continue in the event of one of these "triggering events."
Let's consider the situation where one of your partners unexpectedly dies. In that situation the deceased partner may have a Will which leaves his estate to his wife. Absent any other arrangements, his estate will include his interest in your business. Now, without warning, your deceased partner's wife is your new business partner. Think about your existing business partners or those people who you anticipate going into business with. Would their spouse be able to contribute the same talent and expertise and would you be able to carry on an effective business relationship with that person?
This is the reason for a continuity of business buy-sell agreement. If the agreement is properly structured, the deceased partner's interest can be bought out by the business, allowing you to continue the business and allowing the deceased partner's spouse and family to receive cash for his interest in the business. The purchase price for the buyout is usually financed by life insurance purchased by the business on the life of the partner.
The agreement can also take into account other triggering events such as disability, retirement and bankruptcy. If the agreement contemplates buying out a partner in the event of his disability, it is important that you have a clear definition of "disability." Also, provisions should be made to allow the business to buyout a partner if that partner files bankruptcy or is ordered by a court or by operation of law to transfer property to others. An example of this would be transfers required by a divorce decree or marital property settlement.
One of the most difficult aspects of this type of agreement is the selection of an appropriate formula for evaluating the value of the partner's interest in the business. There are many different ways to determine the value of the business for purposes of this agreement. The value can be based on an independent business appraisal, on a formula that takes into account the value of the assets of the business and/or the income or revenue of the business. Another common arrangement is to let the participating partners/shareholders/members periodically agree upon the value of the business. This would usually require them to meet and revalue the business at certain set intervals.
If the purchase is to be financed from the proceeds of life insurance, the agreement should have provisions addressing the amount, purchase and ownership of the life insurance policies. You should work with your accountant in this area because the way you structure this can have different tax consequences.
Other methods of financing this purchase can be seller financing, setting up and maintaining a "sinking fund" or paying cash out of the assets of the business. Seller financing would require periodic payments to the deceased partner's estate, spouse or family evidenced by a promissory note. If the business elects to finance the purchase through a sinking fund, a set amount of money is periodically contributed to an escrow account set aside exclusively for this purpose. This method is particularly valuable were a shareholder is uninsurable. However you need to keep in mind that there are tax issues relating to the unreasonable accumulation of earnings and you will need to consult with your accountant to develop an efficient structure.
Regardless of what method you choose, you should have some system that provides for the continuity or orderly winding up of the business in the event of an irresolvable dispute, or the death, disability, bankruptcy or retirement of the partner.
This is a prime situation where you need to rely upon the advice and counsel of your team of bankers, attorney and accountant. Unfortunately, a great number of business owners I talk with never consider this agreement. They say that they need to concentrate their efforts on growing the business and the business isn’t big enough to warrant this agreement. If one of the partners dies or wants out, they will just work it out at that time. This begs the question: Just how serious are you about your business? To me, it’s like refusing to draw up a Will or other estate planning. You are just burying your head in the sand hoping that this situation will never occur. But people are dying all the time. Partners have disputes -- many times without any sort of advance warning. When this happens, how will this affect your family? Will they receive compensation for all of your risk-taking and hard work? Or will they be left with nothing? Or even worse – will they be left with bills or a lawsuit from creditors or your former partners?