BUY-SELL AGREEMENTS

Neal A. Deutsch, CFP^®

Published in Rivertown Journal, April 2007

Owning a business is one of the great American dreams. As we begin and grow our business, very often we tend to either start with or take on a partner. While we put our all into the viability and success on a day-to-day basis, one area often overlooked is the issue of business succession. A buy-sell agreement is a document between partners that dictates what will happen to the stock, or partial ownership of your company in the event of the partnership separating due to any number of reasons. Death, disability or retirement is just some of the reasons that partners may choose to liquidate or dissolve an association.

The agreement serves many purposes. At the time of a buy out, the major issue is the question of the buy out price, or business valuation. The document will state how the valuation of the business is determined. Many considerations will take place in this area: the nature and history of the business, book value of the stock, past and projected sales, earnings and cash flow capabilities, as well as the value of similar companies in the same field. Other reasons to value your business may be to find the partners equitable value to determine the gross estate for estate tax taxation in the case of the death of a partner, or to provide for equitable distribution where some of the children in the family are active, and some are not. A proper valuation of the business will be necessary if you have an existing business and plan to take in a new partner.

The terms of the buy out will be outlined as all cash, a term of payments, or perhaps an exchange of property. There is no hard and fast rule as to how the purchaser will be paid, and any term of sale, which is acceptable to all parties, may be utilized. Most often, the stock held by the seller is exchanged for a predetermined amount, known as Stock Redemption. In this arrangement, the seller, the seller’s family or estate will surrender the stock in exchange for a predetermined sum, deemed as the buy out amount. Once the exchange is made, the seller is now out of the business, and the buyer becomes sole or a larger stockholder, depending on the amount of total initial partners.

Life and disability insurance may play a major role in creating a cash pool to transact the sale, or to aid in the efficient continuation of running the business. By taking a life insurance policy out on each of the partners in the amount of the value of that partner’s share of the business, creating a fund immediately available upon the death of a partner to pay for the buyout. This method alleviates the need to use company assets, which may be needed for inventory and day-to-day expenses.

In the case of short or long term disability of a partner, a properly designed disability policy will aid in helping to avoid the additional drain of assets as the company may need to hire additional help to replace the disabled partner, adding to the company expenses. This will allow for a fund that will continue to pay the disabled partner a salary, while a temp may replace him or her for that period of time. If the company does choose to supply the employees with a disability plan, it should be noted that the taxation of the benefits to the employee would vary based on who pays the premium. If the employer pays the premium with before tax dollars, the benefit payments to the employee will be taxable. If the policy is owned by the employee and paid for with after tax dollars, the benefit will be tax free. It is important to consult your advisor as to the best advantage to utilize. Depending on the amount of partners, structure of the business, corporation or partnership, there are many ways to formulate an effective buy-out.

Neal A. Deutsch is a Certified Financial Planner^™, Registered Securities Principal and President of Chestnut Investment Group in Suffern, NY, helping people with financial planning since 1984. Please feel free to call Neal at 845.369.0016 or email him with your questions at neald@chestnutinvestment.com Feel free to visit his website at www.chestnutinvestment.com