All posts in Business Issues

08 Apr

Buy-Sell Agreements: Stability in a Time of Uncertainty

In Business Issues,Buy-Sell Agreements by admin / April 8, 2013 / 0 Comments

Estate Planner May-Jun 2000

Retirement doesn’t have to be right around the corner before you plan for it. Have you considered how your stake in your company will be handled when you retire? What if you were to die before retirement? Will your family be forced to negotiate the sale of your interest? A buy-sell agreement can help circumvent many business transition problems and stabilize what could otherwise be difficult periods of uncertainty.

What Are Triggering Events?

A buy-sell agreement is a popular tool to transfer a stake in a business upon the occurrence of a predefined event called a triggering event. Some triggering events include:

  • Death,
  • Disability,
  • Retirement,
  • Bankruptcy,
  • Divorce,
  • Voluntary or involuntary termination of employment, and
  • An involuntary sale of stock.

After the triggering event occurs, the buy-sell agreement dictates the sale according to the agreement’s terms. The agreement specifies, among other things, who will buy the stock and at what price. (Although we are discussing the sale of stock, a buy-sell arrangement applies equally to interests in partnerships and limited liability companies.)

Both your business and your family benefit from a properly designed buy-sell agreement. For example, at your death, a buy-sell agreement will reduce much of your family’s economic uncertainty. Without the agreement, difficult negotiations could ensue between your family members (who may have an unrealistic view of the company’s value) and surviving shareholders.

Buy-sell agreements also help preserve the surviving shareholders’ control of the company by restricting stock transferability and controlling who may become shareholders. An orderly transition can help prevent the business from being dissolved in a distress sale caused by internal dissent.

Stock in a closely held business is generally an illiquid asset, but the buy-sell agreement can provide your estate with sufficient cash to pay:

  • Death taxes,
  • Debts and administration costs, and
  • Support and living allowances for family members.

Furthermore, during your lifetime, you hold the best bargaining position to maximize the purchase price. Family members generally do not have sufficient knowledge of the business or leverage to exact the best possible offer from the corporation or other shareholders. And obtaining a predetermined value for your stock can offer certain federal estate tax benefits because in some cases your stock may be given a lower valuation for estate tax purposes.

Types of Buy-Sell Agreements

The buy-sell agreement is generally structured as either a stock redemption or a cross purchase. Here’s a closer look at each:

Stock redemption. Stock redemption allows the business to use its funds to buy your stock. Life insurance commonly funds the company’s purchase of the shares when you die. The stock redemption structure assures that the premiums are paid on time, giving you peace of mind. If insurance funds your stock purchase, the stock redemption approach could also alleviate some administrative burdens not covered with a cross-purchase structure. Though the stock redemption structure is easier to administer, the cross-purchase structure can lower the overall tax burden.

Cross purchase. Surviving shareholders buy back your stock at your death under a cross-purchase buy-sell agreement. The arrangement is almost as if your shares are pieces of a pie. When one shareholder experiences a triggering event, the others must buy his or her shares. While it seems simple, it’s not. The cross-purchase agreement places unequal financial burdens on newer or younger shareholders. For example, a 10% shareholder may be required to purchase a 90% shareholder’s interest.

You can create a hybrid agreement if you are not sure which structure best suits your needs. The hybrid agreement gives the corporation the option to buy the stock. If the corporation’s option expires, then the shareholders are either given the option to buy the stock or are required to buy it. This arrangement allows the parties to determine the best structure at the most opportune time.

Which Buy-Sell Agreement Is Best for You?

If you think a buy-sell agreement may be useful to you, please contact us. Our professionals would be happy to discuss your business situation to arrive at the solution that fits your needs.

08 Apr

Placing Your Family Business in a Trust

In Business Issues by admin / April 8, 2013 / 0 Comments

Estate Planner May-Jun 2000

How Your Children Fit Into Your Succession Plan

You’ve spent a lifetime growing a successful business. Now, as you near your retirement, is a good time to consider your company’s future. Ask yourself these questions:

  • What will happen to your business when you retire?
  • How will your children divide their shares if some are active in the business and some are not?
  • What is the best way to prevent the IRS from siphoning off more than its share of estate tax?
  • How will conflicts among shareholders be resolved?
    You can control the outcome of these issues by placing your family business in a trust when the business is part of your estate. Let’s take a closer look at issues to consider.

Choosing a Trustee

Your choice of a trustee is important because the trustee has ultimate control of your share of the business. Generally, selecting one of your children as the sole trustee may lead to problems down the line. Your children may have different ideas about your business than you. They may:

  • Want to sell the company,
  • Continue to aggressively grow it, or
  • Use cash flow from the business to support their lifestyles.

For example, one child may want to retain a major part of the year’s earnings for expansion or reserves, while children outside the business may want to distribute the profits as dividends.

To prevent dissension, consider choosing a professional trustee. But remember he or she ordinarily has a duty to minimize risk, and closely held businesses are risky by nature. Therefore, a professional trustee may be inclined to sell the business to reduce risk. But if you want your family business retained and have chosen a professional trustee, you can provide specific instructions about the circumstances under which you would permit the business to be sold, thus limiting the chances of liquidation.

On the other hand, some circumstances may lead you to choose one of your children as the trustee. If you feel comfortable that your children will be fair to each other after you’re gone, it might be best to choose the child who is most active in your business. This way the trustee is the most qualified to make decisions about the trust as it pertains to the company’s operation.

Allocating Profits

A critical question to consider when determining how the trust should allocate profits is: Should you leave it up to your children or should you address the issue in your estate plan? The children who continue with the family business deserve a salary and additional rewards for continuing to work to make the business successful. But the children outside the business whose inheritance is tied to the company’s success should be rewarded accordingly.

For example, assume that the closely held business is a farm. A measurable reward for return on capital (cash rents) clearly belongs to shareholders. The balance of the profit belongs to the return on labor (which should go to the child in the business) and the return on bearing risk (which belongs to all the children).

Examining Tax Strategy

Don’t overlook the importance of assessing your business structure and choosing the one that works best for your situation. Generally, a C corporation structure reduces after-tax returns because profits are taxed twice. The income is taxed once as corporate income, and again as a dividend to the individual investor. To prevent double taxation, consider another structure, such as S corporation, limited partnership or limited liability corporation (LLC). Profits from partnerships and LLCs have the advantage of being taxed only once, at the ownership level. But be careful! A partnership structure may expose the partners to liability they were protected from as corporate shareholders. A restructuring by your estate (after a step-up in basis) will minimize the tax cost of converting a C corporation to a new structure.

Making an Informed Decision 

After you’ve considered the benefits and caveats, you can make an informed decision on how to best structure the trust to meet your particular needs. And after you consider issues such as who will be your trustee, the extent of the trustee’s control and how to balance tax benefits with liability risk, your next step is to consult a professional. We can help you design your trust and focus your estate planning to best fit your needs.