When a business has just a handful of owners, the sudden death or departure of one of them can shake the whole operation. Remaining owners may wonder how to keep things running smoothly, while the family of the departed owner may be counting on that ownership stake for income. A business continuation plan, built around a written agreement made in advance, can help everyone involved avoid confusion and conflict later on.
Why a Written Agreement Matters
Closely held corporations, meaning businesses owned by a small group of shareholders, often depend heavily on the people who run them. When one of those owners passes away or becomes unable to continue, the rest of the ownership group has to figure out how to keep the company stable.
At the same time, the heirs of that owner are usually looking for two things: a way to replace lost income and a fair method for converting their inherited ownership interest into something they can actually use.
A buy-sell agreement, put in place while all the owners are alive and able to agree on terms, sets out ahead of time what happens to an owner's share of the business if death, disability, retirement, or another defined event occurs. Having this understanding in writing tends to reduce disagreements and helps the transition go more smoothly for everyone.
Common Structures for Buy-Sell Agreements
Most buy-sell arrangements for stock-based businesses fall into one of three general categories.
- Stock redemption plans, where the corporation itself agrees to purchase some or all of a departing shareholder's stock. These can take different forms, including buying back the entire interest, a partial interest, or using a redemption approach tied to specific tax code provisions designed for situations involving estate costs.
- Cross purchase plans, where the remaining shareholders personally buy the departing shareholder's stock. The purchase can be split among the remaining owners in proportion to what they already held, or divided differently based on what the agreement specifies.
- Hybrid or wait-and-see plans, which give the corporation the first opportunity to buy the stock. If the company does not act within an agreed time period, the remaining shareholders get the chance to purchase it themselves. If neither the company nor the individual owners step in, the agreement typically requires the corporation to complete the purchase.
What to Think About Before Choosing a Plan
There is no single structure that works for every business. Owners typically need to weigh the upfront and ongoing cost of each option, how easy the plan will be to administer over time, and how the different owners feel about each approach.
Tax treatment is also an important piece of the puzzle, and the rules in this area can be detailed and subject to change. Certain transfer arrangements can also raise what is sometimes called a transfer for value concern, which can affect how proceeds are taxed later on.
Because these issues touch on legal and financial matters that vary from one business to another, it is wise to work with qualified legal and financial professionals when putting a plan together. This article is general information only and is not tax, legal, or financial advice. Always confirm current rules and figures with a qualified advisor before making decisions.
A thoughtful business continuation plan can give owners and their families more peace of mind about what happens down the road. If you would like to talk through how insurance can support a buy-sell agreement for your business, the team at Flynn Insurance Agency in Kings Park is glad to sit down with you and discuss your situation.
This article is general information, not legal, tax or financial advice. Coverage depends on the terms, conditions and exclusions of each policy. Talk with a licensed agent about your situation.
