A buy-sell agreement specifies how business interests will be transferred, to whom, and under what circumstances. In a cross purchase buy-sell agreement, each business owner agrees to buy the business interests of an owner who dies, becomes disabled, retires, or otherwise leaves the business. A cross purchase agreement may be appropriate any time there is more than one business owner.
The business owners should visit with an experienced attorney to discuss a buy-sell agreement. Once they have decided on the cross purchase format, the attorney will draw up the agreement. In designing the agreement, several important issues are involved: buy-out events, valuation, funding, and buy-sell variations.
Nearly all buy-sell agreements provide that the death or retirement of an owner triggers a buyout. The parties sometimes overlook the possibility of the disability or divorce of an owner. In the event of a divorce, for example, the stock could end up in the hands of the ex-spouse, which the remaining owners may not want. Other triggering events can be the firing of a minority owner or the personal bankruptcy of an owner.
Valuation
One important requirement for a business purchase agreement to work is a consensus on the value of the business. An agree-upon amount or method prevents valuation disputes between a departing owner or a deceased owner's estate and the remaining owners. Also, an accurate valuation allows the parties to anticipate how much funding will be necessary for a buyout. Valuation can be based on a formula detailed in the agreement. The agreement can require the parties to revalue the business ever year or require a professional business appraiser to value the business.
Funding
The company can simply create a sinking fund using a savings account or another conservative investment. The company can borrow the money from a bank, but there will be interest costs. The bank also may be reluctant to lend money to a business if a key person has died or is leaving the company. Assuming the agreement allows, the company can make installment payments. This is often the only option where other liquid funds are not available, which is frequently the case with most businesses. When a buy-out event occurs, the company would pay the departing owner or a deceased owner's heirs a set amount each year determined by the language in the buy-sell agreement. The departing owner or his/her heirs may have a concern as the whether the surviving owners can profitably run the business. The most common funding option is for the business owners to obtain life and disability buy-out insurance on the other owners. In the event of an owner's death, the surviving owners can use the death benefit proceeds to buy the deceased owner's interest. Disability buy-out insurance can serve the same function, if the owner leaves due to disability. In both cases, the funds are available at the precise time necessary.
Business owners should meet with their attorney, tax professional, and financial professional to fully discuss all options before creating a buy-sell agreement.
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This information is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.
Andrew Martin
542-4803
7282 Plantation Rd. Suite 400
Pensacola, FL 32504
atlasfinancialstrategies.com
This article originally appeared on Santa Rosa Press Gazette: The Cross Purchase Buy-Sell Agreement