Buy-Sell Plan Helps Business Live On

If you run a business, the people who depend on your success include your family, your partners, your managers, your employees, maybe even your customers and suppliers.

And if you die or become disabled, all of these people could lose their future.

Business owners, even those who plan ahead, often overlook the importance of their own well-being to those who depend on them. What’s more, death and disability pose a particular threat to any small or mid-sized business because such companies are the creatures of their owners and may thrive only so long as they do.

Fortunately, you can stave off the financial consequences of death or disability with a legal document called a buy-sell agreement backed by life and disability insurance.

What is a buy-sell? Why is insurance a key part of any buy-sell?

In essence, a buy-sell backed by insurance:

* Gives your family a ready buyer for your business in the event that you die or become disabled.

* Gives the buyer--perhaps your management team, perhaps your partners--the wherewithal to carry out the transaction.

In plain English, a buy-sell backed by insurance brings peace of mind to all who depend on you, guaranteeing that your family realizes the value of your labors if you die or become disabled.

It also guarantees that the fruit of your labors--your business--survives you under the control of people who may run it without interference from family.

You can shape a buy-sell to fit any need, no matter how complex the ownership structure of a business. Buy-sells cover businesses with equal or unequal partners, incorporated or not, or those with majority and minority stockholders. You can even shape a buy-sell so that an employee stock ownership plan--an ESOP--becomes the owner of your company upon your death or disability, or even a competitor.

The crucial element in a buy-sell is the life and disability insurance that puts teeth into the agreement, and if some owners find it difficult to commit to the planning necessary to do a buy-sell, others blanch at the cost.

They shouldn’t--because doing nothing can prove far more costly, says Paul J. Glass aNorthwestern Mutual Life Insurance Co. agent in Woodland Hills.

“A buy-sell is a legal mechanism that creates a buyer for the owner’s business interest,” Glass says.

“It facilitates a smooth transition of ownership after death or disability, and it assures the owner that the value of the business interest goes to his or her family--so that the fate of the family does not depend on the fate of the business.”

Since tax law plays an important role in any buy-sell, Glass says, the business owner needs good legal and accounting advice, plus the help of an insurance agent skilled in business succession planning.

Glass gives the example of two partners in an unincorporated business valued at $1 million, each partner having put $50,000 in start-up capital into the business 10 years earlier. They negotiate a buy-sell with $500,000 in life insurance on each partner.

One of the partners dies. In accordance with the buy-sell, the other uses the proceeds of the life insurance to buy out the family of the missing partner. In exchange for the $500,000, the surviving partner becomes the sole owner of a $1-million business.

The survivor immediately sells the business for $1 million--and pays capital gains taxes on $450,000, not on the $1 million realized from the sale of the business.

Why? The survivor paid $500,000 for the one-half interest in the business possessed by his or her late partner and sold that interest for the same sum. Hence there is no gain on that part of the sale price.

The partner owes tax only on the difference between what he or she put into the business 10 years before and the sale price of that original interest. In plain English, the partner owes capital gains tax on $450,000--that is, $500,000 minus the $50,000 put into the business in the first place.

Clearly, Glass says, the buy-sell benefited the surviving partner in two ways--by giving him or her sole control over the business and by easing the tax burden due upon sale.

Tax law is complex and changes often, Glass says, and so does the value of any business. So you can’t negotiate a buy-sell and forget about it. Instead, because a buy-sell is a business planning tool, you must keep tabs on it to make sure that it continues to fit the need of everybody involved, he says.

“An insured buy-sell provides certainty that the terms of the agreement will be carried out,” Glass says.

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Columnist Juan Hovey may be reached at (805) 492-7909 or via e-mail at [email protected].