When assessing a client's estate planning needs, it is important consider any business interests owned by the client. Business interests are frequently one of the client’s most valuable assets and absent other planning, pass according to the provisions of a client's Will or Living Trust. Unfortunately, often a direct transfer of the business interest to beneficiaries is not optimal for the operation or continuation of that business after the death of the client.
For example, if the surviving spouse or children have not been active in the business, their lack of operational experience can cause reduce the business’ value quickly or even cause the business to collapse completely, rendering it valueless. If the business is a large part of the client's assets and provides a good income stream, this scenario will pose a serious problem for the spouse and minor children if the business is lost. Another potential issue arises when only some, but not all, of the client’s children, are active in the business. If all the children receive equal shares of the business, the non-active children may try to manage the business without knowledge, again causing the value the business to decrease significantly. Alternately, the non-active children may demand the purchase of their interest by the children active in the business, creating substantial cash-flow problems.
However, by engaging in Buy Sell planning it is possible to significantly reduce the likelihood that such problems will arise. Buy Sell planning is also important when the client is not the sole owner of the business. In situations where a portion of the business is owned by a nonfamily member, but the deceased client's interest now goes to beneficiaries a Buy Sell Agreement can protect the nonfamily member and the business from new owners who,
- Have no interest in being a part of the business;
- Want to be part of the business but have no idea how to run it; or
- Are unrealistic about the value of the business.
All of these situations can decrease the value of the business, create cash flow problems if the beneficiaries demand a salary, or simply wish for cash in exchange for their interest.
All of these situations are common, however by executing a Buy Sell Agreement the business owners can proactively limit the chance that a sudden change of circumstance for one owner can bring down an entire business.
The primary benefit of a buy sell agreement is the protection provided to the health of the businesses. A Buy Sell Agreement typically provides that under certain circumstances, one of the parties has the right or obligation to purchase the interest of the other party for whom a triggering event occurred. The agreement typically provides for specific events, such as death, disability, desire to sell, or retirement that trigger the parties’ obligations to one another. Additionally the Buy Sell Agreement provides provisions for determining the value of the business interest and terms for the payment of the price over a fair time span to all the parties. Further, beneficiaries can receive fair value for their business interest over a reasonable period, without adversely affecting the health of the business. It is important to review and update the buy sell agreement periodically as the situation changes.
In circumstances where the potential for conflict exists between siblings or with non-family owners, the parties will "fund" the agreement with life insurance, to be paid in the event of the death of one of the parties. The life insurance proceeds pay the deceased's estate for the deceased’s share of the business and beneficiaries involved in the business operation or the non-family owner are free to run the business without interference. To the extent that the value of the business exceeds life insurance, the Agreement provides for the payment of the remaining value over a reasonable time, with reasonable terms.
I often meet resistance when I discuss a buy sell agreement with some of my business clients. That resistance usually melts away when faced with one of two questions:
- "Do you want to be partners with your partner's spouse, if your partner passes away?
- Will your children’s collective efforts result in the continued success of the business?
While client’s may like a partner’s family members, they are generally not interested in being partners with them and when they truly take the time to consider their children’s interests most clients acknowledge that ownership is better passed to particular children.
A business interest is often a large part of a client’s assets. A properly drafted Buy Sell Agreement is important to insure that beneficiaries benefit from that asset in the best possible manner. Having a Buy Sell Agreement allows a client's family to be treated fairly as part of the purchase agreement and allows the remaining parties to continue running the business with no management interference while purchasing the business interest for a fair price and at reasonable terms. This is why any complete discussion of estate planning issues is not complete without addressing the client’s business interests.