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The Cross Purchase Buy – Sell Agreement
Business owners are builders. They spend their lives building a company that provides goods and services to their clients and provides themselves a living. But nothing can tear down that lifetime work faster than their death, or the death of a business partner. Often, much of the value of a business dies with the owner.
Any sole proprietor faces two important questions.
Q: If a sole proprietor dies, how can his or her heirs continue the business or keep from selling it at fire sale prices?
The executor of the estate can continue the business, but must find someone willing to run it. The executor can sell the business if heirs wish, but must find a buyer – and the negotiating position of potential buyers will keep improving as the company is becoming less valuable with each passing day following the owner's death.
Additionally, heirs may disagree over what to do with the business. Some may want to keep it going, others may want to cash out. If certain heirs elect to continue the business, those heirs that want out will need to be compensated. If the cash to do this can't be found, this could potentially force liquidation.
Q: How does a sole proprietor keep key employees confident that the business (and their jobs) will be around after his or her death?
If a business partner dies, a surviving partner may find themselves in business with the deceased partner's heirs, who may have different goals for the company. If the heirs wish to sell to the surviving partner, can they be paid? And will the cash needed to buy the business be on hand? These questions can throw the value and continuation of a business into doubt. This could make creditors more likely to call loans, and key employees less likely to stay with the firm.
Buy-sell agreements may help answer these questions and mitigate these problems.
A buy-sell agreement is basically a deal struck by interested parties in a company to sell their share of the business to another person if they should die. These agreements are often funded by life insurance. Owners take out a life insurance policy on themselves with a key person as the beneficiary. If the owner passes away, the key person can use the proceeds to buy the business from heirs. This way, the key person can continue to work and operate the business and access funds to purchase it. The heirs would receive a fair price for the business (a price agreed to before the owner's death). They also get an easy liquidation of the estate.1
The business owner gains the satisfaction of knowing that the firm will continue after his or her death, and that its employees will not contend with uncertainty about their jobs. In addition, a buy-sell agreement may engender more productivity and loyalty from key employees, who recognize that the possibility of ownership may be ahead for them.2
In the case of a partnership, life insurance policies are purchased on each partner with the other partner named as the beneficiary. The proceeds from one partner's death can be used to purchase the deceased partner's interest from the heirs. The agreement also gives heirs and partners some assurance that the business will continue after their deaths.2
As with the death of a sole proprietor, heirs may be freed from certain business worries since the sale can happen rather quickly. They also know they won't be forced to sell the business under duress. They will get a predetermined fair price for the business. Also, estate issues will be settled more quickly allowing them to move on with their lives.1
Buy-sell agreements do have certain disadvantages. First, participants have to trust and verify that each partner keeps his or her policy in force. This isn't as simple as making sure premiums are paid. Usually, the policies are owned personally and not by the business. If a partner goes through a bankruptcy, creditors may seek the cash value of the attached life insurance policy. (The policy premiums are not tax-deductible for the business owner.)3
Also, as the number of partners increases, the number of policies grows exponentially – as does the cost of the buy-sell agreement. Two partners require two life insurance policies, but a partnership of three will require six policies as each partner will be the beneficiary of two other partners.2
Finally, if business partners have a wide disparity in age or health, the older or less healthy partner will be paying much more for the agreement than the younger, healthier partner.3
Before you make a decision about how you'll protect the future of your business, it may be wise, in addition to researching your options, to speak to a qualified professional who can guide you through these complex choices.