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Business Succession Planning - normally goes hand in hand with effective Estate Planning. As a business owner you have invested many years of hard work into your business. You have worked long hours, taken risks and made sacrifices that many others would never do. And now you have built up something worth protecting! If you are a Sole Proprietor, how would you or your family ever get the 'fair market value' of your business as a 'going concern' if you were unable to continue the business due to disability or death? If you have Partners or other Principals involved in the business, what would happen if they became disabled for a extended period of time or permanently?
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How long could they continue to be paid company profits when they are no longer productive? How and when would they be deemed disabled? Who would make that determination? What if a Partner or Principal died, how would their Estate be paid their share of the 'fair market value' of the business? These are some good questions? The kind that could keep a small business owner up at night if they do not have a 'Plan of Action' in place!
A Buy-Sell Agreement is a legal document that is the very cornerstone of business succession planning. It spells out exactly what the terms of the buy out will be between business owners. The agreement also 'pegs' the value of the business, thereby prearranging the purchase price for not only the buy-out itself, but also for Estate Tax purposes.
Kelley Insurance & Financial has developed relationships with leading law and accounting firms who specialize in this area of planning. Many times a 'Certified Business Appraisal' is needed to establish the purchase price for the business. A properly drafted Buy-Sell Agreement provides for a business interest to be purchased in the event of death, total disability and/or retirement of a business owner. Having a predetermined plan of continuation and succession allows for an orderly transition of the business interest. This enables the business to survive and also allows the business owner (or their family) to get full 'fair market value' for their business interest as a 'going concern'.
The issues regarding business continuation and survival are much more critical in small to medium sized proprietorships, partnerships and corporations with closely-held stock. Normally the business owner's greatest asset is the business itself, which they have worked long and hard for (perhaps a lifetime).
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Let's take a look at some of the concerns for all the parties involved:
- The value of the business as a 'going concern' is usually much higher than it is as a 'gone concern' after the death, disability or retirement of the business owner. Therefore 'pegging' the value as a going concern by using a Buy-Sell Agreement assures the business owner (or his family) will receive full market value for their asset. In addition, Federal Estate Taxes are calculated on the value of the business on the date of death. Liquidity problems (in order to pay taxes) are normally incurred when business assets are sacrificed at 20-30 cents on a dollar due to fire-sale situations.
- Creditors, banks, bonding companies, etc. may rescind the businesses lines of credit which are needed in order to operate the business. Creditors may also 'call' prior loans made to the business due and payable in full.
- Customers or clients may not feel comfortable any longer about doing business with the firm, which of course means future revenues and company 'Good Will' is effected.
- Employees may no longer be comfortable with the situation and may seek employment elsewhere, perhaps even with another competitor.
- Income received by the owner's and/or their family is reduced or cut off. If applicable, Estate Taxes are due if death occurs and any outstanding business debt will be required to be paid in full.
- In case of the death of a Proprietor or Partnership, it is the law in most states that in the absence of a prearranged agreement the business must be liquidated. There is no choice or alternative. In the absence of a Buy-Sell Agreement, the surviving partner(s) become liquidating partner(s) and are responsible for closing down their own business. They must pay their share of the business debts and render a full accounting to their partner, or to the personal representative of their estate. After liquidation, the surviving partner(s) must divide any net proceeds with the deceased partner's estate.
- The deceased partners surviving family has no control of the business during liquidation and has no claim to any business assets until the final accounting is complete. After the final accounting is complete they will receive their share of the shrunken business assets.
A family owned business, where children or other family members would like to continue the business after their parent(s) death, disability or retirement has special planning needs. The value of the business could be inherited by a son or daughter working in the business, thereby eliminating concern for funding the purchase price of the business interest itself. However, there are still issues and concerns even with a properly drafted Buy-Sell Agreement.
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Family Business Concerns:
- The surviving spouse may not be involved in the business, however depends on the income from the business to survive. How will they receive the value of their deceased spouse's business interest if the business interest is inherited? The children could perhaps pay an income to the surviving spouse for their lifetime, but what if the business has a rough transition with cash flow problems or tough economic times hit?
- There may be other children not involved in the business with no desire to continue the business. However, much of the value of the business owner's estate may be wrapped up in the business itself. How will the inheritance of the children not continuing the family business be equaled out? This could be a big area for family contention without prior arrangements
- Even with a properly drafted Buy-Sell agreement and no family contentions, the real show stopper can be the Federal Estate tax due on the value of the business? Normally the value of a business is not liquid. It may be locked up in accounts receivable, equipment, good will, real estate, etc. Estate taxes are of course due within 9 months in cash. Therefore, business assets which are needed in order to run the business may have to be sacrificed to acquire the necessary cash to pay the Estate Tax, unless other arrangements have been made to pay the tax.
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The Buy-Sale Agreement - The answer to all these possible nightmares is to have a prearranged Buy-Sale Agreement and FUND it! This will facilitate the sale and transfer of business ownership to the remaining co-owners at the disability, death or retirement of another owner and make sure the funds are available to do so! In the case of a Sole Proprietor, a buy-sale agreement ensures a buyer for the business and at 'fair market value'. The agreement in the case of a Sole Proprietorship could be made with a 'Key Employee' or family member who would like to take the business over. We have also seen competitors enter into agreements to buy each other out.
A Buy-Sale Agreement is a contract between two or more parties which stipulates how the business will be the purchased, for what price, the terms and conditions of the purchase and the triggering events. Triggering events in most Buy-Sale Agreements must include:
- Disability
- Death and/or Retirement of Business Owners
There are several types of Buy-Sell Agreements available. Click the links below in order to view information regarding the various types of Buy-Sale Agreements;
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How do you Actually Fund a Buy-Sale Agreement
As discussed above, a Buy-Sale Agreement creates a market for your business interest by facilitating a smooth transfer of ownership and spells out the terms of the purchase. However, it does not provide one cent towards funding the Agreement in order to actually make the purchase happen. Therefore without proper funding in place to actually execute the purchase of the business interest, the Agreement may just be a piece of paper.
What are the options in actually funding the Agreement? You could go to the bank and try to borrow, but we all know how hard that is when business is good. Never mind applying for a business loan just after a Key Partner or Principal dies, becomes disabled or retires. That is why most people fund these Agreements with Business Life and Disability Insurance, which GUARANTEES that the funds will be available when needed.
Again, there are three triggering events to a Buy-Sale Agreement. Click the links below in order to view information regarding Funding Arrangements for various Buy-Sale Agreements:
Kelley Insurance & Financial is a leader in providing not only the most competitive product solutions, but also lending assistance in finding the most efficient way of funding the Buy-Sell Agreement. We work with many Metro area Attorney's and Law Firm's who focus their practice on Business Continuation Planning. Therefore, the proper recommendations and solutions can be put in place, including preparing and and all documents required. We also work with our client's council when they have relationships already established with Attorneys.
Don't wait, call our office today for a no cost - no obligation assessment of your situation and we will make recommendations as to the best way to solve your 'Business Continuation' needs.
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