Business Survival for Families-Part II

Last week I discussed three strategies for transferring the family business to family members. An often critical element in a well designed family transfer strategy is a well-crafted buy-sell agreement. More often than not, I find that no buy-sell agreements are in place. In many other cases, the current buy-sell agreement no longer reflects the wishes of the business owner.
A buy-sell agreement is simply a contractual arrangement providing for the mandatory purchase; right of first refusal; or purchase option of the shareholder’s interest upon the occurrence of certain triggering events such as death, disability, or retirement. A buy-sell agreement can work for all types of businesses including C corporations, S corporations, partnerships or limited liability companies (LLC).
The primary reason a business owner would want a buy-sell agreement is to provide for stability and continuity of the family business in a time of transition. An important advantage of a buy-sell agreement is it prohibits the transfer or sale of ownership to unwanted third parties which gives the family members peace of mind.
It is important that you work with your attorney to choose the right type of buy-sell agreement depending on the type of business and what you are trying to accomplish. The three main types of buy-sell agreements include:
  1. Cross-Purchase Agreement. A cross-purchase agreement is one where the remaining shareholders are required to buy, or given a right of first refusal over the shares of the deceased or withdrawing shareholder.
  2. Redemption Agreement. In a redemption agreement, the business itself is required or given an option to buy the shares.
  3. Hybrid Agreement. In a hybrid agreement, the business typically has the first opportunity to purchase the shares and any shares the business does not buy must be purchased or optioned to the other shareholders.
The business owner and attorney must make a decision based on who the buyer or buyers will be for the business. Life insurance often plays a critical role in buy-sell agreements by providing instant liquidity needed to fund purchases. If you use a cross-purchase agreement and have several shareholders then the number of policies required can become burdensome due to each shareholder having to own a policy on every other shareholder. This complexity can be reduced by using a redemption buy-sell agreement since there is only one buyer…the business. Be careful if you are a C-corporation because the alternative minimum tax may come into play under a redemption agreement.
Business succession planning and buy-sell agreements can be tricky and many people avoid the planning simply because they choose to postpone the hassle. But having a plan in place can save a business and make an easy transition for the family at a critical time such as the disability or death of a key owner. If you do not have a plan in place I recommend you meet with your attorney and establish some type of plan and then continue to review your plan periodically to make sure the plan continues to meet your goals.