![]() What factors should they consider in structuring their buy-sell agreement? Three individuals, A, B, and C, create a corporation and are the initial sole shareholders. In addition, an insurance limited liability company, discussed later in this article, can also be used to maximize creditor protection and other tax benefits.Įxample. In some cases, the agreement might be a hybrid of However, those complications can usually be managed, and the benefit of having the life insurance proceeds available to purchase the interests generally outweigh any potential detriments.Ī buy-sell agreement can be structured as a redemption agreement or a cross-purchase agreement by the surviving owners. ![]() This can ease the financial strain on the entity and the remaining owners.Īs discussed immediately below, the use of life insurance can complicate a buy-sell agreement depending on the structure of the agreement. The life insurance proceeds are used to purchase the deceased owner’s interest, or at least as much of it as can be covered by the insurance. However, it is very common to fund the obligations to purchase interests upon the owners’ deaths with life insurance. The entity and its owners may have sufficient resources to pay for any interests that may be bought pursuant to the terms of the agreement. Using life insurance to fund a buy-sell agreementĪ buy-sell agreement does not need a funding mechanism to be valid. In the latter case, it is especially important that the buy-sell agreement be reviewed periodically to ensure that the formula still generates an appropriate value for interests in the entity. In other cases, a valuation formula may be specified. In some situations, the buy-sell agreement simply may provide that an appraisal of the interests will be done at the time in question. The buy-sell agreement sets forth how the value of a transferring owner’s interests are to be determined. Other events might include the owner’s permanent disability or the termination of an owner’s employment with the entity. A possible involuntary transfer, such as one that could result from a divorce or bankruptcy, can also trigger purchase rights or obligations. The triggering events for a buy-sell agreement can go beyond death and voluntary lifetime transfers. Accordingly, a properly drafted buy-sell agreement can prevent the interests of a deceased business owner from passing to others whom the remaining owners would not want to have interests in the entity, and it can also provide liquidity to the estate of a deceased owner. It also usually gives the other owners and the entity, in some combination, the right (and sometimes the obligation) to purchase the interests of an owner when the owner dies or wishes to make a lifetime transfer of his or her interests. In very general terms, a buy-sell agreement (which may be part of a shareholders’ agreement, an operating agreement, a partnership agreement, or other agreement) is an agreement among owners of a closely held business that restricts the rights of the owners to transfer their interests in the entity. The creation of a separate entity to hold life insurance is increasingly being used by practitioners in buy-sell agreement planning to avoid tax traps and other pitfalls. Having a properly drafted buy-sell agreement is key in avoiding conflict and memorializing how life insurance proceeds are to be used at the death of a business owner. Life insurance is an effective tool that business owners can use to implement the provisions of a buy-sell agreement by providing liquidity at the death of an owner to both his or her business and family. ![]() A version of this article originally appeared in the September 2019 issue of Thomson Reuters’ Estate Planning journal.īuy-sell agreements are critical when dealing with a closely held business and yet often ignored or given short shrift by business owners.
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