Business succession planning, and estate planning for business owners seems like a complicated issue, but in actuality it is easily understood. But regardless of how easy or difficult the concept is to understand, it is absolutely imperative for any business owner to understand these concepts.
. . . However, one of the more common concerns among business partners is how to transfer the interest of a deceased partner to the surviving partner while at the same time transferring the value of the deceased partner's interest to the deceased partner's family. The most common way to articulate this concern: "I don't want to end up having to run the company with _________'s spouse." While often spoken in jest, there is a tremendous amount of truth spoken in that sentence every time.
Enter the "Buy-Sell Agreement." What is so wonderful about the Buy-Sell Agreement is that the ownership of the business remains in the hands of the surviving partner while the value of the business is transferred to the family of the deceased. As long as the intent is not for the family of the deceased partner to run the business, then it is truly having your cake and eating it too.
The most common type of Buy-Sell Agreement is referred to as a "Cross-Purchase" Agreement which involves each partner purchasing life insurance on the other partner naming themselves as the beneficiary. When one partner dies, the other partner will theoretically have a sufficient amount of liquidity from the proceeds of the policy to buy out the family who would otherwise inherit the shares. Although some clients have a concern that the family may not turn over the shares, the whole purpose of the Buy-Sell Agreement is that each partner binds and restricts the shares themselves so that the family is obligated to turn over the shares. The end result? The surviving partner owns the company and the family of the deceased partner ends up with the cash equivalent.
When multiple partners are involved in may be too cumbersome for each partner to purchase a policy on every single other partner, and inequalities in health and life expectancy (think cost of insurance) along with unequal ownership portions of the business make a cross-purchase agreement improbable. Under a "Stock Redemption"-type agreement, the business itself purchases and owns a policy on each of the partners, and upon the death of one of them, the business then has the added liquidity to purchase back the shares of that deceased partner. The end result? The deceased partner's family ends up with the cash equivalent of the share, while the business ends up with the shares that it can either retain or distribute to the remaining partners.
The fundamental differences of the "Cross-Purchase" and "Stock-Redemption" -type agreements are explained above; however, there are tax issues relating to estate, income, and capital gains taxes as well as key strategic elements which make HUGE differences when evaluating these agreements as options. But the end goal is the same--to be able to ensure a seamless continuation of a business while at the same time, transfer the cash value of a deceased partner's share to the family...and a properly-planned and drafted Buy-Sell Agreement is essential to that end.