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Funding a Buy Sell Agreement

When business partners enter into a buy sell agreement, one of the pertinent issues or items for the partners to discuss is how the buy-out will be funded. The purchasing business entity or purchasing party can obtain the funds to purchase business interests from a variety of sources, which are discussed below.

The purchaser always has the ability of self-funding the purchase.  If the purchaser does not have the required cash to purchase the interest, issues may arise whereby the seller will request some type of security interest.  Furthermore, if the purchaser lacks the cash to purchase the interest in full and equity in assets to fully secure the seller, a seller may request the buyer obtain a life insurance policy whereby the seller or the seller’s designee is the beneficiary of the policy until the purchase terms have been complied with.

Apart from a self-funded purchase, the most common source of funds for a buy-sell agreement is insurance.  Multiple types of insurance such as life insurance or disability insurance could be used to fund the buyout of the seller’s interest.  Where the triggering event for the purchase of the applicable interest is death, life insurance on the individual can be a very clean means by which to fund the purchase.  However, what if a disability or the retirement of an individual leads to the need to purchase such individual’s ownership interest?  Under these circumstances, life insurance may not be very useful as a source for funds.  To be useful as a source of funds for a buyout, a life insurance policy may need a significant cash value.

When the buy-sell agreement is between the owners of the business, it will likely be necessary for each owner to carry insurance on the life of each of the fellow business owners.  Therefore, multiple policies may be needed if each owner is separately insured.  Further, consider how many policies may be needed if there were say 8 different partners or business owners? If a redemption agreement is used, the owners do not insure the lives of the other owners, but rather, the business must purchase a joint-life policy or separately insure the life of each owner who the business has the obligation to redeem.

The types of life insurance policies could include term life insurance, cash value life insurance, whole life insurance, universal life insurance and survivor joint life insurance.  In regards to the need to purchase an owners interest because of a disability, the owners should consider disability insurance.  In many respects, it may be more likely for a business owner to be disabled than pass away during a time in their life when they still own the business interests and thus a purchase would be necessary.  Therefore, business owners should consider the need for disability insurance to fund a buyout, in addition to having life insurance available.

This article was written by John McGuire, a business attorney and tax attorney at The McGuire Law Firm in Denver, Colorado. Please remember this article was prepared for informational purposes and you should always speak with a business attorney or other counsel to discuss your specific issues & circumstances.

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Types of Buy Sell Agreements by Denver Business Attorney

In a prior article, buy sell agreements were discussed in general, regarding the potential benefit to small business owners.  The article below has been drafted by a business attorney to provide general information regarding certain types or forms of buy sell agreements that small business owners may be able to use for their buy sell agreement.

A cross purchase agreement is a form of buy sell agreement whereby the owners of the business will enter into an agreement holding that is one of the business owners withdraws from the business, the remaining business owners will acquire the withdrawing owner’s business interests.  The acquisition of the interest can be directly from the business owner, or from the owner’s estate.  The purchase price for the business interest will be determined and dictated by the cross purchase buy sell agreement, and the funding for the purchase price is the remaining (or contracting) owners of the business.  Thus, the business does not pay for the interest that is being acquired.  A cross purchase buy sell agreement can be contrasted to a redemption type buy sell agreement.  Under the redemption agreement the business entity agrees to redeem the contracting owner’s interest when a specific event (triggering event) occurs.  The specific triggering events could be the withdrawal of an owner, the death of an owner or other circumstances that will trigger the entities requirement to redeem or purchase the interest.

Business owners can also create a hybrid type buy sell agreement that is a combination of the cross purchase agreement and redemption agreement.  Under the hybrid version of a buy sell agreement, the business entity has the primary right to purchase or redeem the business owners interest and the remaining business owner can be allowed (or perhaps required) to purchase the withdrawing owners interest to the extent the entity does not redeem or purchase the interest.  The order of priority can also be reversed whereby the remaining owners have priority to purchase the withdrawing interest.  However, it is important to note that if the entity is a C corporation, if the remaining shareholders have the primary obligation to purchase the withdrawing shareholder’s shares, but the corporation actually purchases the shares, the remaining shareholders are treated as if they received a dividend from the corporation to the extent of the corporation’s earnings and profits.

Business owners can also structure a buy sell agreement whereby the sale would be to a designated successor.  The successor could be a complete outsider with no synergy with the business or an individual intertwined with the business.

A buy sell agreement can also be established as a sale to an ESOP.  The ESOP would be designed to invest in the securities of the corporation that created the ESOP, and could provide a tax exempt means by which employees could participate in the business.

Thus, there are multiple options when drafting a buy sell agreement for your business.  You can discuss these matters with a Denver business attorney if you have questions regarding a buy sell agreement or other business matters.  The McGuire Law Firm provides a free consultation with a business attorney in Denver or Golden Colorado.

Buy Sell Agreements Discussed by Denver Business Attorney

Many individuals who own closely held business interests, such as an interest within a limited liability company or closely held corporation will enter into a buy sell agreement.  These individuals (and perhaps their estate) may accomplish a number of planning objectives and goals with a buy sell agreement, and potentially optimize income, gift and estate tax outcomes and implications depending upon the overall situation.

When an individual owns a closely held business, which can be considered an interest in a business where no readily available public market exists, they may have a number of problems and related concerns regarding the closely held entity.  The individuals within the business have likely invested significant capital, and their family’s economic security and growth may depend upon the success of this business.  Moreover, if an owner of the business left due to disability, death, retirement or otherwise, the remaining owners may not want to work with a different or “new” individual, or with a member of the departed owner’s family.  Therefore, a goal and objective of a buy sell agreement is wealth preservation (and liquidity of the ownership interest under certain circumstances)  and the remaining business owners control, continuity and overall maintenance of the  business without the need to bring in “outside” third parties who may not be wanted.  There are multiple issues to discuss regarding a buy sell agreement such as the funding and pricing of the agreement and of course the overall income, gift and estate tax consequences from the agreement, which cannot be discussed all within one agreement.  Thus, the remainder of this article will outline the general types of buy sell agreements, which are discussed below.

Generally, when an owner departs from a business there are two common purchasers of the business interest.  The remaining owners may purchase the interest through a cross purchase agreement and the business entity may purchase the interest through a redemption agreement.  These cross purchase agreement and redemption agreement may be able to be combined into one hybrid buy sell agreement.  You may also have the possibility to have an agreement whereby the business interest is sold to an individual or business that previously, was not interested in the venture, or even to employee via an employee stock ownership plan.  The common types or forms of a buy sell agreement may be called or referred to as: cross purchase agreements, sale to a successor, redemption agreements, a hybrid buy-sell agreement (this would be a combination between a cross purchase and redemption agreement) and sale to ESOP (employee stock option plan).  These types of agreements will be discussed in more detail in later articles.

If you think a buy sell agreement could benefit you, contact The McGuire Law Firm to speak with a Denver business attorney.  A Denver business attorney can assist you with your options and the drafting of necessary contracts and agreements.

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Denver Business Attorney Discusses a Buy Sell Agreement

A Denver business attorney at The McGuire Law Firm can assist you with your business needs.  From business formation and contracts to tax analysis and the sale or transfer of your business, a business attorney at The McGuire Law Firm can assist you!  The video below has been prepared to provide general information regarding a buy sell agreement.

 

Contact The McGuire Law Firm to schedule a free consultation with a business attorney.  The McGuire Law Firm has law offices in Denver and Golden Colorado!