The language of a BUY-SELL Agreement is typically drafted by an attorney; funding comes from the use of life insurance policies. Obviously, the first step will involve the valuation of the business, or to establish a method of valuation for that entity. Remember that this valuation process is crucial. If properly done, an acceptable arm's length valuation established by the parties may well fix the business valuation for estate tax purposes.

Based on this established valuation, business owners and partners can easily determine the funding level required. Most often, these funds will come from life insurance, rather than from company funds. Since the business will be in need of replacing a deceased partner or owner, it cannot afford to impair it's financial standing.

In a properly drafted agreement, contingencies may be allowed for, such as a change in ownership percentage, key employees as owners, and other valuable considerations. A written agreement is the only way that everything is clearly understood. Don't forget that this agreement may very well be a tremendous aid in establishing methods of procedure in advance, obviously saving a lot of time and trouble, in advance.

There are several ways that the buy-sell agreement can be funded in terms of the agreement. It is always a good practice to utilize a specialist in partnership or corporate taxation, because different types of agreements lend themselves to different tax outcomes. Finally, the agreement needs to satisfy the needs of the partners while maintaining sufficient flexibility in the future. Regardless of the type of agreement used, no single consideration lends itself to the use of either the entity-purchase, or the cross-purchase, agreement specifically. Each situation must be carefully analyzed by your professional legal and tax experts.

The types of agreements generally used are:

-Entity Purchase: An entity-purchase agreement is one in which the business agrees to buy individual business owners' interests at death. This is a simple arrangement to understand. The client and the other partners enter into an agreement, and at death the agreement is carried out. The business purchases life insurance on each stockholder or partner. The estate then sells the interest in the company back to the business entity itself in return for the life insurance proceeds. If there is good will involved in the business entity, it is somewhat favorable to use this type of planning. Note that with corporate entities, since there is a redemption of stock at issue, loans or other obligations of the corporation may preclude ANY changes in the capitalization of a company, and of course this can present severe problems.

-Cross Purchase: Under a cross-purchase plan, the partners, or stockholders, agree among themselves to purchase the interest of any partner who dies. Conceptually, this is easy; the difficult arises when funding is purchased, especially in a partnership. Each partner must purchase policies on each of the other partners. In a corporation with multiple shareholders a cross-purchase agreement can mean many policies; therefore, a trusteed cross-purchase agreement, useful with S corporations, may be called for. At any rate, a cross purchase is nothing more than the sale and purchase of a capital asset - the stock - and tax problems are minimal. However, other disadvantages of the cross-purchase agreement, especially with more than two shareholders, may make the choice of this type of agreement problematic. As always, professional legal counsel is called for in the determination of the agreement type; the funding mechanism, the life insurance, can be whatever type may best be suited to the company's needs, be it term or whole life.

For more information of buy-sell agreement, or if you have questions about a buy-sell agreement you are considering or need to fund, please call us at 303-422-1660 for a personal consultation.

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