How to Dispose of Your Interest in a Closely Held Business: Alternatives to Buy-Sell Agreements

Estate Planner Mar-Apr 1999

Selling stock in your closely held business may be difficult due to a limited market for it. Although buy-sell agreements provide the way your interest will be bought and sold, alternative methods allow you to both address these concerns and receive financial benefits from the company without selling your stock.

A Few Alternatives

With proper planning, your company can provide you with significant financial benefits. Here are some alternatives:

Deferred compensation. Under a deferred compensation agreement, your company can pay you after your retirement or death, either for services rendered or as payment for recognition of past work. You and your company can establish a substantial severance package before you leave its employ. The company can deduct the severance payments, if reasonable, as a business expense.

Covenant not to compete. Payments your company makes pursuant to a covenant not to compete can provide additional funds to you. The company can also deduct these payments as business expenses. But the covenant must be reasonable in light of all surrounding circumstances. If the IRS finds the covenant to be suspect, it can treat the payments as a dividend to you and the company will not get a deduction.
Benefit plans. Certain retirement plans, such as defined benefit plans and target benefit plans, can quickly fund large retirement accounts for older employees. Their structure allows larger payments to older employees because the payments to younger employees are projected to continue for a longer period of time. An employee stock ownership plan (ESOP) acquiring the company’s stock can work similarly. This option may be especially attractive because the gain on the sale of your stock to the ESOP can be deferred and receive a step-up in basis at death.

Stock redemption. If your company cannot purchase your interest for cash on your death or retirement, it can redeem your stock in exchange for company assets through a taxable transaction. Then you can either sell the assets or lease them back to the company. Or, the company can create a market for your stock by paying reasonable bonuses to your children or other younger employees that they can use to purchase your stock.

Sale of the company. If the company doesn’t have enough cash to buy you out, the other owners can sell it while remaining involved through employment and consulting agreements. Or, you could wind down the business while your children begin a new, similar business. You receive the accounts receivable of your closed company. In effect, its goodwill will inure to the benefit of your children’s company without there having been an actual transfer.

Charitable remainder trust. If you are charitably inclined, you can use your stock in the company to fund a charitable remainder trust that provides you income and allows you to receive an income tax deduction for the remainder passing to charity when the trust terminates. Your children can have a right of first refusal to repurchase the stock, which may be useful if the charity has no interest in owning the stock. If income is not your goal, then you can make an outright gift of stock to the charity and avoid any gain on the stock gifted while receiving an income tax deduction.

Gifting to children. If you have sufficient other resources, your stock may be an appropriate asset to establish a gifting program to your children.
Spin-offs. If you and other owners are concerned about conflicts, then you may want to consider dividing the company through either a tax free spin-off, split-off or split-up that allows each owner to receive a separate part of the business.



Consider Your Goals

Careful consideration of your goals can help determine how you should dispose of your closely held business interest. Remember, though, that any arrangement must reflect a bargained-for agreement between you and the other parties — a court will look for this if a dispute arises later. If you are interested in learning more about how alternatives to a buy-sell agreement may work for you, please call us. We would be happy to discuss your situation and help you determine how to best dispose of your interest in a closely held business.