A buy-sell agreement Featured

8:00pm EDT October 26, 2007

Evaluating a suitable exit strategy entails weighing both retirement income goals and estate-planning considerations.

“Many business owners who have worked for decades to build a business believe that they cannot afford to retire because they are largely dependent upon their business for immediate cash needs,” says Larry Parkin, senior vice president of SunTrust Bank in Pinellas and West Pasco counties.

Smart Business talked to Parkin about the importance of a good retirement plan.

What types of exit plans are available to business owners?

There are only three dispositions or exit strategies that one can execute with a business during the lifetime or at the death of a business owner. It can be sold, liquidated or gifted away. Certainly, a sale would generate more revenue for the business owner and/or his or her family than either a liquidation or gift of the business. Without proper planning, the business may be worth far less, if not become entirely worthless, upon the death, retirement or disability of the owner. The key to any successful sale requires that business owners work closely with their successors and have a competent and complementary team of financial advisers working together for the common good of both the selling and purchasing shareholder.

A well-formulated exit strategy also provides confidence to business lenders, customers and vendors. All decisions need to be coordinated with the selling shareholder’s retirement situation to ensure that business and estate-planning factors do not compromise the ability of the selling shareholder to maintain an attractive lifestyle in retirement. To facilitate this process, a funded buy-sell agreement is oftentimes the preferred medium to maintain the business for the new owners while providing for the long-term income and liquidity needs of the selling shareholder and his or her family. Indeed, even in sole owner situations, an exit strategy is necessary. In these situations, the business owner often-times seeks out a key employee, supplier and/or competitor to purchase his or her business interest.

What is a buy-sell agreement?

A buy-sell agreement has been used for many purposes over the years. It can be utilized as a tool to either restrict the transfer of shares and/or establish a value of the shares for estate tax purposes. Most importantly, it can be viewed as a means of effectuating control over a closely held business by limiting transfers to unrelated parties, while also providing a market and liquidity for the interest of a selling shareholder and/or his or her estate. A proper buy-sell agreement can also eliminate the need for expensive business appraisals. The well-designed buy-sell agreement should also take into account the business owner’s death as well as other possible triggering events for a lifetime transfer, such as retirement, disability, gifting and other life events.

How is a buy-sell agreement structured?

There are three basic types of buy-sell agreements: (1) the stock redemption agreement, (2) the cross-purchase agreement, and (3) the hybrid agreement. The stock redemption agreement entails an arrangement between the business and business owner whereby the business owner agrees to offer his or her interest to the business at a certain price under certain specified conditions. The agreement is generally binding upon both the shareholder and his or her estate. A cross-purchase agreement is a contract among the owners of a business whereby each agrees to buy the interest of a departing shareholder under certain conditions at a price determined under the agreement. A hybrid agreement is a combination of a redemption and cross-purchase agreement. In most instances, the business interest is first offered to the remaining shareholders and, if that right is not exercised, it is offered to the business itself.

How is a buy-sell agreement funded?

Generally, life insurance is the preferred tool to fund a buy-sell agreement. With a redemption agreement, there is a need for only one policy per stockholder. A cross-purchase agreement requires each shareholder to own separate policies on the lives of all other owners. The most common triggering events in a buy-sell agreement are death, disability and retirement. While life insurance proceeds are available in the event of death, funding for either disability or retirement is more complicated. To lessen the impact on the business and/or shareholders, agreements typically provide for a modest lump sum plus installment payments payable out of business cash flow and/or assets. For disability, a disability insurance policy may be utilized. Loans against policy cash values can also be used to fund a buyout in the event of retirement or disability.

SunTrust Private Wealth Management is a marketing name used by SunTrust Banks, Inc., and the following affiliates: Banking and trust products and services are provided by SunTrust Bank. Securities, insurance and other investment products and services are offered by SunTrust Investment Services, Inc., an SEC registered investment adviser and a member FINRA and SIPC.