In the previous issue of this newsletter, we made a strong case for creating a buy-sell agreement for co-owned businesses. To summarize, if owners agree in advance of any transf

If owners agree about how to appraise business value and set the terms of payment in advance of any transfer event, they can avoid the heated and often damaging negotiations that can occur when one owner leaves the company. In this newsletter, we continue making our case for creating a well-drafted and recently reviewed Buy-Sell Agreement by outlining several other advantages.

There is a strong case for creating a Buy-Sell Agreement for co-owned businesses. If owners agree about how to appraise business value and set the terms of payment in advance of any transfer event, they can avoid the heated and often damaging negotiations that can occur when one owner leaves the company.

In this issue, we continue making our case for Buy-Sell Agreements by outlining several other advantages of a well-drafted and recently reviewed Buy-Sell Agreement.

Controls Transfers

A Buy-Sell Agreement can control all transfers of business ownership to the benefit of both the owner wishing to transfer ownership and the owners who want to acquire ownership. This agreement can assure that a selling owner (or his or her estate) is selling for fair value and under terms and conditions that are acceptable to all parties. Further, the agreement assures remaining owners that any transfers of ownership must be at least offered to them. This eliminates the potential for an outside party or a co-owner’s spouse or children to assume ownership of the business, all of which could negatively affect the company’s management, control, and value.

A Valuation for All Reasons

A Buy-Sell Agreement sets forth an agreed-upon method of valuing the business that applies to all transfers.

Owners’ valuations of their own businesses may be much different than the IRS’s or a co-owner’s. If owners rely on a “stated value” or a formula-based value, they may run into difficulties with both the IRS and other owners, because value in privately owned businesses changes often and rapidly. If Buy-Sell Agreements are not revised every year, their valuation formulas will favor either the buyer or the seller, and provide ample opportunity for disputes. Owners can avoid this by requiring a value determination from a certified business appraiser, but even that provision needs to be drafted carefully.

Similarly, if co-owners buy a living co-owner’s interest, the value of the selling owner’s interest will likely be lower in the buying co-owners’ opinion than the seller’s. However, if their Buy-Sell Agreement requires the involvement of a business appraiser, they can avoid this impasse.

It is best to agree—today—on a method of valuing the business when no owner knows which side of the transfer table he or she will be sitting on. Not knowing whether you will be a buyer or a seller tends to ensure that all owners work to protect the interests of both the buyer and seller.

If owners don’t have an existing, binding process for valuing the business, ideally using a credentialed business appraiser, they can expect disagreements when one of the owners leaves the business. We strongly recommend that owners take the reins and design a valuation appraisal process suitable for their companies, and we would be happy to help you do so.

The Fine Print

In a Buy-Sell Agreement, owners can fix the terms and conditions of any transfer of ownership, including interest rate, length of buyout period, and security. In addition, it often is possible to provide the funding for future ownership acquisition, either during an owner’s lifetime or after death.

Finally, Saving on Income Taxes

Buy-Sell Agreements should be drafted to anticipate the likeliest transfer event: the sale of an ownership interest from one owner to another. While they require additional planning and document drafting, intra-owner sales can be designed to save as much as 30% of the company’s cash flow from taxation. For example, if the purchase price is $1 million, the cash flow required to pay a departing owner could be reduced by $300,000 or more. To repeat, this does take additional tax planning—but the result is well worth it.

We strive to help business owners identify and prioritize their objectives with respect to their businesses, their employees, and their families. If you have questions on this topic, we can help with more information or a referral to another experienced professional.

er event about how to appraise business value, and about the terms of payment, they can avoid the heated and often damaging negotiations that can occur when one owner leaves the company.

In this issue, we continue making our case by outlining several other advantages of a (well-drafted and recently-reviewed) buy-sell agreement.

Controls Transfers

A buy-sell agreement can control all transfers of business ownership to the benefit of both the owner wishing to transfer ownership and the other owner (or owners) wanting to acquire ownership. This agreement can assure a selling owner (or his/her estate) of a purchase for fair value and upon terms and conditions that are acceptable to all parties. Further, the agreement assures remaining owners that any transfers of ownership must be at least offered to them. This eliminates the potential for an outside party or a co-owner’s spouse or children to assume ownership of the business, thereby diminishing management, control and value.

A Valuation For All Reasons

A buy-sell agreement sets forth an agreed-upon method of valuing the business that applies to all transfers.

Your idea of your business’s value may be much lower than the IRS’s or a co-owner’s. If you rely on a “stated value” or on a formula-based value, you may run into difficulties with both the IRS and with other owners because value in privately owned businesses changes often and rapidly. If your buy-sell agreement is not revised every year, its valuation formula will favor either the buyer or the seller and provide ample opportunity for disputes. Avoid this by requiring a value determination by a certified business appraiser—even that provision needs to be carefully drafted!

Similarly, if you are buying a living co-owner’s interest, the value of his/her interest will likely be lower in your opinion than his/hers. If, however, your buy-sell agreement requires the involvement of a business appraiser, you can avoid this impasse.

It is best to agree—today—upon a method of valuing the business when no owner knows on which side of the transfer table he/she will be sitting. Not knowing whether one will be a buyer or a seller tends to ensure that all owners work to protect the interests of both buyer and seller.

If you don’t have an existing, binding process for valuing the business, ideally using a credentialed business appraiser, you can expect disagreements when one of the owners leaves the business. We strongly recommend that you take the reins and design a valuation appraisal process suitable for your company.

The Fine Print

In a buy-sell agreement, you can fix the terms and conditions of any transfer of ownership, including interest rate, length of buyout period and security. In addition, it is often possible to provide for the funding for future ownership acquisition at either lifetime or death.

Finally, Saving Income Taxes

Buy-sell agreements should be drafted to anticipate the likeliest transfer of ownership event: the sale of an ownership interest from one owner to another. While it requires additional planning and document drafting, intra-owner sales can be designed to save as much as 30% of the company’s cash flow from taxation. For example, if the purchase price is $1 million, the cash flow required to pay a departing owner could be reduced by $300,000 or more. To repeat, this does take additional tax planning—but the result is well worth it!

If you have any questions about establishing a business continuity agreement for your company or its role in helping you exit your business in style, please contact us to discuss your particular situation.

Park Avenue Securities LLC (PAS) is a wholly-owned subsidiary of The Guardian Life Insurance Company of America (Guardian). PAS is a registered broker-dealer offering investment products, as well as a registered investment adviser offering financial planning and investment advisory services. PAS is a member of FINRA and SIPC. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Please consult your tax, legal, or accounting professional regarding your individual circumstances.

The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact an attorney or a tax or financial professional. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, you should consult their legal, accounting, tax or financial professional. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Owner-Based Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice that you need. This is an opt-in newsletter published by Business Enterprise Institute, Inc., and presented to you by our firm. We appreciate your interest. Any examples provided are hypothetical and for illustrative purposes only. Examples include fictitious names and do not represent any particular person or entity.