A buy-sell agreement is a formalized business continuation plan that is
designed to provide for the orderly disposition or continuation of an
individual’s ownership in a business. There are two basic types
to consider, the Cross-Purchase Agreement and Stock Redemption.
The buy-sell agreement allows the holder of a business interest to enter
into an agreement that will provide for the future sale of that interest
should death, disability or retirement occur. Under the terms of the buy-sell
agreement, the specified buyer is legally obligated to purchase the interest,
and the interest holder or his/her estate is legally obligated to sell
the interest upon the occurrence of one or more specified events.
A properly structured business continuation agreement has many advantages. It can:
- Control the value of the business for estate tax purposes and the estate
taxes due on the assets.
- Ensure the continuity or orderly disposition of the business.
- Protect the surviving owners from gaining an undesirable co-owner (such
as a member of the deceased interest holder’s family).
Under the Cross-Purchase Agreement, each interest holder agrees to buy
the interests of the other owners under the terms of the agreement. A
straightforward Cross-Purchase Agreement works well for a smaller business
where there are fewer than four owners. Typically, with this arrangement,
the co-interest holders personally own life insurance policies on the
lives of each of the other interest holders. This generally becomes too
complex when dealing with a large number of owners. Funding can also be
cumbersome, confusing, and potentially more expensive. These difficulties
have led to the creation of other types of Cross-Purchase Agreements.
One example is a Trusteed Cross-Purchase Agreement involves the creation
of either a revocable or irrevocable trust. The trustee would be responsible
for handling all the paperwork, owning and maintaining the life insurance
policies, and ensuring parties fulfill the terms of the buy-sell agreement.
A Trusteed Cross Purchase Agreement can streamline the agreement and eliminate
complexity and expense.
Following are some advantages of a Cross-Purchase Agreement:
- The surviving interest holders receive a step-up in basis equal to the
price they paid for the withdrawing or deceased owner’s shares.
- Policy cash values are available to the owners, because they personally
own the policies on each other’s lives.
- The incorporated business does not have to own a life insurance policy
to fund the agreement, thus avoiding any corporate alternative minimum
tax on the death proceeds.