A Buy-Sell Agreement (BSA) is a lifetime contract providing for the transfer of a business interest upon the occurrence of one or more triggering events as defined in the contract itself. For example, common triggering events include the retirement, disability, or death of the business owner.
An interest in any form of business entity can be transferred under a BSA, to include a corporation, a partnership, or a limited liability company. Also, a BSA is effective whether the business has one owner or multiple owners.
As a contract, a BSA is binding on third parties such as the estate representatives and heirs of the business owner. This feature can be invaluable when the business owner wants to ensure a smooth transition of complete control and ownership to the party that will keep the business going.
Subject to certain Family Attribution Rules under Internal Revenue Code § 318, a BSA can help establish a value for the business that is binding on the IRS for federal estate tax purposes as provided under Internal Revenue Code § 2703.
Entity Buy-Sell, Cross-Purchase Buy-Sell, and Wait-and-See Buy-Sell Agreements
A BSA is commonly structured in one of three general formats: An Entity BSA, a Cross-Purchase BSA or a Wait-And-See BSA. Under an Entity BSA, the business entity itself agrees to purchase the interest of a business owner.
Conversely, under a Cross-Purchase BSA, the business owners agree to purchase one another’s interests. The Wait-And-See BSA gives the entity a first option to purchase the interest before the remaining business owner(s).
In addition to these three general formats, a One-Way BSA may be used when there is one business owner and the purchaser is a third party. The selection of the appropriate BSA format is critical for a variety of tax and non-tax reasons beyond the scope of this discussion.
However, no BSA is complete without a proper funding plan. Like a beautiful automobile without fuel in the tank, a BSA without cash to fund the purchase is going nowhere.
Funding a Buy-Sell Agreement
Some common options to fund the purchase obligation under a BSA include the use of personal funds, creating a sinking fund in the business itself, borrowing funds, installment payments and insurance. Of these options, only the insured option can guarantee complete financing of the purchase from the beginning.
Accordingly, a proper BSA will include both disability buy-out insurance and life insurance. Since the health of the business owner determines their insurability, any delay in acquiring appropriate coverage could be fatal to the success of the BSA and, with it, the survival of the business itself.
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