Buy-Sell Financing

     True or false: Most family business owners want their businesses to be liquidated when they retire, become disabled or die? If you answered false, then you are correct. However, the sad truth is that most family businesses fail to survive the retirement, disability or death of the owner.
     In this article, we will survey the fundamental key to the survival of a family business – a Buy-Sell Agreement (BSA).

Introduction

     A BSA is a lifetime contract providing for the transfer of a business interest upon the occurrence of one or more triggering events, as defined in the contract itself. For example, common triggering events include the retirement, disability or death of the business owner.
     An interest in any form of business entity can be transferred under a BSA, to include a corporation, a partnership or a limited liability company. Also, a BSA is effective whether the business has one or multiple owners.
     As a contract, a BSA is binding on third parties such as the estate representatives and heirs of the business owner. This feature can be invaluable when the business owner wants to ensure a smooth transition of complete control and ownership to the party that will keep the business going.
     Subject to certain Family Attribution Rules under Internal Revenue Code § 318, a BSA can help establish a value for the business that is binding on the IRS for federal estate tax purposes as provided under Internal Revenue Code § 2703.

Three Flavors

     A BSA is commonly structured as either an Entity BSA, a Cross-Purchase BSA or a Wait-And-See BSA. Under an Entity BSA, the business entity itself agrees to purchase the interest of a business owner. Conversely, under a Cross-Purchase BSA, the business owners agree to purchase one another's interests. The Wait-And-See BSA gives the entity a first option to purchase the interest before the remaining business owner(s).
     In addition to these three general formats, a One-Way BSA may be used when there is one business owner and the purchaser is a third party.
     However, no BSA is complete without a proper funding plan. Like an automobile without fuel, a BSA without cash to fund the purchase is going nowhere.

Funding Options

     Common methods to fund a BSA purchase obligation include use of personal funds, creating a sinking fund in the business itself, borrowing funds, installment payments and insurance (disability buy-out and life insurance). Of these options, only the insured option can guarantee complete financing of the purchase from the beginning.
     Caveat: Since the health of the business owner determines their insurability, any delay in acquiring appropriate coverage could be fatal to the success of the BSA and with it the survival of the business itself.