SMALL BUSINESS CONTINUITY

Kim Jones

Financial Advisor

Raymond James & Associates

Much of the wealth in this country has been created through the efforts of small business owners. Small business owners are an incredibly hard working group. Often, virtually every waking hour is spent helping the business grow. The family may be involved in the business. No one deserves their wealth more than someone who has overcome the odds and created a successful business.

But these entrepreneurs can be a difficult group. They are so tied up in their businesses that they often don't take time to plan. They can be secretive about their affairs and unwilling to trust the fate of their business to "outsiders." And yet, if a business owner fails to plan for his/her eventual death or retirement, or the possibility that they may become disabled, the business owner is literally risking that which he/she holds so dear...the business itself. Buy/sell agreements can help.

Simply stated, a buy/sell agreement obligates one party to sell and another to buy some or all of a business interest upon the occurrence of some designated event, typically death, disability and/or retirement. To be most effective, buy/sell agreements should be accompanied by some type of a funding mechanism to provide the buyer with the cash needed to meet the obligation.

Life insurance and disability insurance are most often used to fund buy/sell agreements in the event of death and disability, respectively. A cash value life insurance policy can also be used to provide cash to the buyer in the event of retirement. A buy/sell agreement may also be structured to provide for installment payments from the buyer to the seller. A buy/sell agreement can be created for both incorporated and unincorporated businesses. For federal estate tax purposes, the buy/sell agreement must be structured as an arm's length agreement providing for a fair price to be paid. Some fairly recent changes to the estate tax rules have made this a bit more challenging.

There are two basic forms for the buy/sell agreement. The first is the cross purchase agreement. Under a cross purchase agreement, the owners of the business enter into the buy/sell agreement among themselves obligating each other. For example, Winken and Blinken are equal shareholders of X Inc. Under the cross purchase agreement Winken and Blinken each agree to buy the other's half of the business in the event of the other's death, disability or retirement. To fund the agreement, each buys a cash value life insurance policy on the life of the other.

The cross purchase agreement is very popular with companies having few owners. The surviving owners benefit from an increase in their cost basis when the purchase is ultimately made. The cross purchase agreement becomes more difficult to fund when their are more than two owners. For example, if Winken and Blinken were joined by Nod a total of six life insurance policies would be required. Also, the premiums on the policy may vary based on the ages and health of the owners.

With an entity purchase agreement (also called a redemption agreement), the owners of the business contract with the company itself. The company is then obligated to buy the share of the owner who has died, retired or become disabled. If the agreement is funded, the company owns the policies. Redemption agreements can be structured to take advantage of special estate tax rules (Sec. 303) and they may reduce the number of policies required.

Of course, this brief article is no substitute for a careful consideration of all of the advantages and disadvantages of this matter in light of your unique personal circumstances. Before implementing any significant tax or financial planning strategy, contact your financial planner, attorney or tax advisor as appropriate.

By utilizing some form of a buy/sell agreement, the small business owner insures the continuance of the business he/she has worked so hard to create. This makes life much easier for the remaining partner(s) in the business as well as the family members.

For more information, contact Kim Jones, Financial Advisor, Raymond James & Associates at 561.835.1040.