BuySell Agreements Considerations and Common Mistakes Business Owner Market The small business administration defines a small business as an enterprise having fewer than 500 employees There are more than 28 million small businesses in the US ID: 552352
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Slide1
Business Succession Strategies
Buy-Sell Agreements:
Considerations and Common MistakesSlide2
Business Owner Market
The small business administration defines a small business as an enterprise having fewer than 500 employees
There are more than 28 million small businesses in the U.S.*
Approximately 543,000 new business are started each month*More will close their doors for good*
*Statistics provided by the U.S. Census Bureau and are through 2011Slide3
Business Owner Market
Family owned businesses
30 percent survive into the second generation
12 percent are viable into the third generationOnly 3 percent operate into the fourth generation and beyond
Nearly half do not have a succession plan in place
W
ealth transfer planning
only 61 percent of business owners surveyed think they have sufficient resources to divide assets among family membersSlide4
Business Owner Market
Business Protection
62 percent said they have not made any provisions for dealing with a shareholder or key employee who becomes sick or diesSlide5
Where Do We Go From Here?Slide6
Business Succession Planning
Exit Planning
- Buy-Sell AgreementsBusiness Protection PlanningBusiness Owner Retirement Planning
Key Non-Owner PlanningSlide7
Buy-Sell Agreements
Restrict transfers
Avoid conflicts
Business Continuity - Create a market for owner’s business at certain triggering events
- Facilitate smooth transition of management & control
- Provide mutually agreeable price & conditions
- Provide liquidity
- Sets value for estate planning purposes
Purpose and Benefits of a formal agreementSlide8
Buy-Sell Agreements
Articles of incorporation
Operating agreement
Partnership agreementLoan documentsFranchise agreements
Deferred equity compensation agreements
Consider Existing Restrictions & AgreementsSlide9
Buy-Sell Agreements
Rights and obligations following a triggering event
Valuation issues
Funding issuesFinancing termsConsider future potential shareholders (especially minor children)
Right to purchase life insurance policies
Key Provisions to ConsiderSlide10
Buy-Sell Agreements
Consider the Right Plan
- Cross Purchase Slide11
Cross Purchase
Arrangement in which each surviving owner agrees to buy out the interest of any departing or deceased owner
Owner, beneficiary and premium payer are typically the same person (NOT a spouse) Slide12
Cross Purchase
Advantages
Simplicity for 3 or fewer owners
Purchasing owners receive step-up in basisLife insurance proceeds received income tax-free & do not increase the value of the business
Disadvantages
May require several policies with > 2 owners
Owner may unintentionally let policy lapse
Premiums may or may not be deductibleSlide13
Buy-Sell Agreements
Consider the Right Plan
- Cross Purchase - Entity PurchaseSlide14
Entity Purchase
Arrangement between business entity and its owners
Business redeems interest of an owner in case of death, disability or retirement
Business is owner, beneficiary and premium payer of life insurance policySlide15
Entity Purchase
Advantages
Simplistic for > 3 owners
If funded with life insurance, only one policy per shareholder is required
Disadvantages
Surviving/remaining shareholders do NOT receive a step up in basis on the deceased/departing owners shares*
Assets held to fund plan may increase value of corporation
Life insurance subject to corporate creditorsSlide16
Entity Purchase for S Corps
Surviving/remaining shareholders of an S Corporation
CAN
receive a step up in basis on the deceased/departing owners shares if…..S Corp uses cash basis accounting instead of accrual
S Corp is taking advantage of the short year tax electionSlide17
Buy-Sell Agreements
Consider the Right Plan
- Cross Purchase - Entity Purchase
- One WaySlide18
One Way
Providing an exit strategy for one-owner businesses
Established between owner and key employee
Creates a buyer for small business owners with no partners or co-shareholdersBuyer receives a step-up in basisAllows for business continuationSlide19
Buy-Sell Agreements
Consider the Right Plan
- Cross Purchase - Entity Purchase
- One Way
- Wait & SeeSlide20
Wait & See
Sets forth triggering events, purchase price and payment terms w/o identifying the purchasers until the event occurs
Corporation typically has first option to purchase share of deceased or exiting shareholder
Remaining shareholders have option if corporation doesn’t exercise its option
Corporation is required to purchase any shares not purchased under first two options
Provides greatest flexibility
Provides greatest riskSlide21
Buy-Sell Agreement Funding Methods
Cash on Hand
- Very liquid, but most business owners put their money to work in the business
Sinking Fund
- Funds may be inadequate if a business owner dies prematurely
- Corp may be exposed to an accumulated earnings tax problem
Borrow Funds
- The loss of a key person might impair the business’s credit worthiness
- Interest costs may be excessive and interest expense may not be deductible
Installment Plan
- Risk of business failing and payments to seller ceaseSlide22
Buy-Sell Agreement Funding Methods
Life Insurance
Complete financing is guaranteed from the beginning
Death proceeds are free from income tax
Generally the most economical as premiums are a fraction of the death benefit
Business credit position is strengthened
If a cash value policy is purchased, equity in the policy can be used for buyout due to retirement or disabilitySlide23
Buy-Sell Agreements
Improper selection of type of Buy-Sell
Improper selection of triggering events
Failure to coordinate related propertiesFailure to consider tax issues
Forgetting that minority shareholders / owners have substantial legal rights
Failure to put it all together
Failure to update
Common MistakesSlide24
Questions