A typical small business owner spends so much time attending to immediate tasks that planning for the future is often neglected. This is too bad, because business owners who neglect planning now may cause their families and business partners to pay dearly for this oversight later.
If a buy-sell agreement has not been drawn, you may not have planned sufficiently for the future. The agreement decrees how a business, or a share of a business, will be transferred upon death, disability or retirement.
It can be between partners, a business entity and its stockholders, or an owner and a key employee, and it determines who will receive a business or its share and how the sale or transfer will be funded, and provides a means for paying personal estate taxes after the transfer.
There are three types of buy-sell agreements — a stock redemption plan, which is an agreement between a corporation and its shareholders; a cross-purchase plan, which is an agreement usually among shareholders or partners; and a wait-and-see buy-sell plan, which offers flexibility and tax and economic advantages that take the best from the first two options. In the third scenario, a corporation can exercise its buy option or waive its right, thus triggering the cross-purchase option.
Regardless of which buy-sell plan you choose, consult with a professional to help avoid tricky tax and procedural pitfalls. Equally important, a financial professional can present appropriate funding options.
Nearly 25 percent of all business successions don’t go as planned because of a lack of adequate funding to carry out the plan. The number is even higher among family businesses because, while many family business owners spell out transfer arrangements, they don’t plan how to fund the transfer.
When a business owner is disabled or opts out of the business for other reasons, other owners get first crack at that share of the business. Of course, they need the money to acquire those shares. When a business or its shares becomes available because of the death of an owner or shareholder, surviving owners again get the first option to buy, even though the business interest is usually willed to a family estate.
Most buy-sell plans include the stipulation that surviving family members, if not previously involved in the day-to-day business operations, sell their interest to surviving owners. Cash received for this interest helps meet family estate tax obligations. It also ensures the business is in the hands of the people best qualified to run it.
Self-funding, borrowing and insuring a buyout are the three basic ways most plans are funded.
With self-funding, surviving owners or shareholders can pay for the business interest outright or through an installment plan. Buyout funds can also be accumulated through the establishment of a sinking fund, a savings plan in which business owners put aside money on a regular basis for the sole purpose of buying shares when they become available.
This funding arrangement helps money accumulate for the future, while at the same time earning interest. Borrowing provides the money up front, with interest payments figured into future payments.
But what if death or disability happens before enough funds have accumulated to meet the buying price? Or what if borrowing becomes tight because the departure has an adverse affect on business? And, can a deceased owner’s estate afford to wait for an installment plan?
That’s where insurance comes in.
Bought by either the company or by partners on each other’s lives, insurance is the surest method of providing cash when it’s needed. Through a variety of insurance programs such as split-dollar, in which an insured owner and other partners split the cost, tax-advantaged savings can be accomplished now while future payout is guaranteed.
Whole life insurance, which builds cash value, can also provide funds when events other than death trigger a buyout clause. Many companies sell disability insurance to specifically meet buy-sell needs.
The existence of a buy-sell plan ensures the orderly transition of a business. A proper funding vehicle ensures the money will be there when the time comes.
Plan for the future now. Your business depends on it.
Jan Bell is the owner of Bell & Associates Planning in Atlanta, an affiliate of National Financial Services Group (www.nationalfinancialservicesgroup.com). Her planning strategies focus on the conservation of assets for present and future generations through business and estate planning. Reach her at (770) 399-0417 or [email protected]. Securities and Investment advisory services are offered solely by Equity Service, Inc., a Registered Broker/Dealer and Investment Adviser, 1050 Crown Pointe Parkway, Suite 1000, Atlanta GA 30338. National Financial Services Group is independent of Equity Services Inc.
