In our last few blogs, we have discussed issues that arise following the death of a spouse. A significant concern for surviving spouses during this time is the impact of the death on the operation of a family business, especially when that business is a primary source of income. This can be an especially thorny problem for the surviving spouse if they were not active in the operation of the business, because they may then be at the mercy of key employees, business partners, or even family members whose interests are very different from their own. The possibility of a surviving spouse facing this situation is the best reason for a business owner to consider Buy-Sell planning.
Business interests are frequently one of a client’s most valuable assets, so it is important to consider how to handle such assets following the client’s death. A direct transfer of the business interest to a surviving spouse or children, according to the provisions of a client's Will or Living Trust, has the potential to cripple the operation of the business and significantly reduce its value especially if the surviving spouse or children have not been active in the business. Lack of operational experience, conflicts with staff and business partners, or lack of interest in running a business can all reduce the business’ value quickly or even cause the business to collapse completely, rendering it valueless. This is where a well-drafted Buy-Sell Agreement can assist in making a smooth transition following the client’s death
The purpose of a Buy-Sell Agreement is to establish how business interests transfer following the death of a business owner. Buy-Sell Agreements can be made between co-owners, between parents and children, and even between a business owner and their key employees. Typically, a Buy-Sell Agreement provides that 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 also defines what constitutes a “triggering” event, including death, disability, desire to sell, or retirement, to eliminate questions about when a party’s obligation arises. Additionally the Agreement provides a method for determining the value of the business interest and the terms for the payment of the sale price over a time span fair to all the parties. This ensures that following a death, the people active in the operation of the business know what will happen, allowing them to continue operations uninterrupted, and maintain the value of the company.
Often the parties to the Buy-Sell Agreement purchase insurance on the life of the business owners in order to provide funds for the purchase of that owner’s interest at their death. This is especially useful when there are non-family co-owners who may be put in an untenable business situation if the family members have no interest or knowledge in running the business, or want cash now and are unrealistic about the real value of the business. Life insurance proceeds can also be used to ensure that surviving spouses, or other children, receive fair value for the business when only some of the client’s children are active in operations. This allows the active-children to continue running things, without worrying about their surviving parent’s welfare or non-active siblings creating problems with the operation of the business.
A well drafted Buy-Sell Agreement takes into account the myriad of unexpected circumstances that may arise following the death of a business owner and attempts to foster a situation where that death has a minimal impact on operations. This allows survivors to either continue operating the business as usual or easily transition of ownership of the business, for a fair price, to those people the client chose as the next owners.
As always, it is important to remember that engaging in business planning should not be done without having good advice. A Buy-Sell Agreement is a binding legal contract and thus it is important to discuss Buy-Sell planning with an experienced attorney who can explain the substantial operational, tax, and planning impacts that the Agreement imposes on a client’s business.