What Are Buy-Sell Agreements?
Buy-sell agreements are legally binding contracts in which business owners set the terms and conditions of a future sale or purchase of a departing owner’s shares. You can use it to explain how your ownership interest in the business will be distributed or transferred upon your resignation, loss of professional license, retirement, disability, or death.
Lawyers from a law firm in California highlight the importance of buy-sell agreements:
- Maintaining business continuity: Your business co-owners or key employees can buy back your interest in the business without disputes.
- Fair compensation for beneficiaries: If your heirs are not involved in the business, a buy-sell agreement can help ensure they are well-compensated. On the other hand, the company remains in capable hands.
These contracts can be useful estate planning tools for business owners without successors. If you’re considering incorporating one in your estate plan, experienced estate planning attorneys in California can provide legal guidance.
How Do Buy-Sell Agreements Affect Estate Planning?
Business ownership calls for more than just the day-to-day running of operations. It requires a long-term vision for continuity, even after you stop being actively involved. That’s why a buy-and-sell agreement is one of the crucial tools of estate planning for your business. The document has the following impact:
Helps Set a Fair Value
Determining a business’s value can be complex since it is subjective. The process can lead to disputes among co-owners, but a buy-sell agreement can help minimize conflict by providing a valuation method. Overall, it can enhance transparency.
Your business co-owners can use a buy-sell agreement to set the estate tax value of your business estate. So, careful drafting is vital, with the following considerations in mind:
- The sale of your business interest should be at the price outlined in the agreement
- The contract must place specific restrictions on lifetime transfers of the business interest
- The business interest value must be fixed or determined from the buy-sell
- The agreement must be a bona fide business contract and not a transfer for less than it is worth
Determining the fair market value of your business interest may require the involvement of skilled business evaluators. Understating the value of a business asset for estate tax purposes can attract hefty penalties from the IRS. Work loosely with experienced California estate planning attorneys to avoid mistakes that could jeopardize the succession of your business.
Liquidity and Estate Taxes
Once you pass on, some estate taxes may be due, and your business could face liquidity issues if it is a significant asset. A buy-sell agreement can ensure a market for your business interest, providing the required liquidity to cover taxes and other expenses without forcing a business sale.
Protecting Co-Owners
A buy-sell agreement mitigates the risk that heirs not involved in the business may miss out on your business interest. Lack of business inheritance can lead to conflict and disruptions. The remaining business owners can continue running the business without interference, as the terms for transferring your share of the business are already defined.
Further, the agreement can help preserve family relationships as members will be saved from the agony of fighting over the company’s direction or value. Protect your family interests by drawing an explicit buy-sell agreement in your estate plan.
Flexibility in Planning
One benefit of buy-sell agreements is the flexibility they provide. You can tailor the contract to fit different business structures and situations. Buy-sells have four basic structures, with some combinations offering greater flexibility to meet your estate planning needs:
- Entity purchase: The business entity is obligated to buy your interests once you depart
- Cross-purchase: The remaining owners agree to buy a share of your business interests without the business entity being a party to the arrangement
- Unilateral or one-way: The buy-sell is ideal if you decide to sell the entire business to a third party, such as a key employee or family member
- Wait-and-see: If you’re unsure whether the other owners will buy out your share, you can draft a wait-and-see agreement. Priority is given to the business entity to purchase your interest. If it fails, the owners can exercise their option, with the business having an obligation to buy if the owner doesn’t.
Who Finances the Buy Out?
For a buy-sell agreement to be successful, funds must be available to fulfill the terms, without which the owners may be forced to sell assets, seek loans, or file for bankruptcy. Estate planning lawyers in California highlight the following possible funding options for buy-sells:
- Cash
- Borrowings
- Life insurance
- Appreciated property bailout
- Sale-leaseback
- Stock-redemption
- Private annuity
- Installment sale
- Disability insurance
- Deferred compensation
- Self-cancelling installment note
The funding choice generally depends on the business size, structure, tax bracket, levels of cash available, number of owners, age, ownership percentages, and tax brackets. Several funding methods could be applicable.
A Skilled Estate Planning Lawyer Helping You Create a Buy-Sell Agreement in Your Estate Plan
Business succession can be complex if you don’t know the right tools to use. A buy-sell agreement is an effective estate planning tool for business owners who don’t have successors but want a clear exit plan to protect their business interests. Estate planning lawyers in California can help you determine the most suitable buy-sell structure to meet your needs.
The Singh Law Firm has a dedicated estate planning team that can help you draft a clear buy-sell contract to protect your business interest. We work hard to help our clients protect their family wealth by avoiding unnecessary estate taxes in the future. If you’re wondering where to get started with business succession, we are here to help. Call us at 510-901-5375 to schedule a FREE consultation.
