In a business run or shared by a partner or partners, the success of that business is predicated on how well the partners make decisions about the direction of the business, as well as the future of it. These decisions are an integral part of how well a business will do, and having a common desire and common goals will often determine the growth and stability required to keep the partnership healthy and intact.
One thing however, should not be overlooked, and that is having a plan in place should any of those partners become injured, ill, or in a worst-case scenario, dies. This shouldn’t spell the end of the business because of an unfortunate instance where an owner becomes too ill to work, disabled, or forced to retire for any number of reasons.
A buy-sell agreement, used often by people who understand the risks involved in a partnership, protects all of those concerned in the event of such circumstances. It is a vital tool that determines what happens in these types of situations, who will be the owner, or owners, when something unforeseen takes place, as well as how the individual values may change. By establishing a predetermined outcome when a business structure is changed unexpectedly, the owners have the peace of mind of knowing that they have properly prepared for the unexpected.
The agreement determines when and how the business will be sold, giving a source of funds for anyone in the partnership when he or she decides they wish to retire. In the event of a death, the buy-sell agreement will give the survivors the needed funds to handle any estate taxes that must be filed and paid.
The two types of plans most commonly used
While there are several ways to set-up and structure a buy-sell, the two most commonly and most often used are:
ENTITY PURCHASE AGREEMENTS
CROSS PURCHASE AGREEMENTS
In an Entity Purchase Agreement, the business itself maintains an insurance policy on each owner, which allows the surviving partners to purchase the interests of any partner who becomes deceased.
The Cross Purchase Agreement allows each owner to carry a life and/or disability policy on each of the co-owners. The surviving owners have a legal obligation to purchase the ownership rights of any partner who dies. The deceased owner’s estate then sells that interest in exchange for the proceeds from the life insurance policy. This type of policy works best with a small number of owners as it becomes infinitely more difficult to administer with a larger number of parties involved.
The death benefits under both of these plans is exempt from federal income taxes, but under the Entity Purchase plan a corporation can be subject to the corporate alternative minimum tax in certain situations.