Beachside Wealth PartnersFrances Povloski, CRPS, AIFFinancial Advisor131 Second Avenue NorthSuite 200Jacksonville Beach, FL 32250904-246-0346904-246-0346Frances.Povloski@RaymondJames.comwww.beachsidewealth.com

Business Succession PlanningBuy-Sell Agreements

01/01/2020

Business Succession Planning Buy-Sell Agreements

Summary:A buy-sell agreement is a legally bindingcontract in which the owners of a business setforth the terms and conditions of a future saleor buy back of a departing owner's share ofthe business. Specifically, buy-sells controlwhen owners can sell their interests, who canbuy an owner's interest, and at what price.

Buy-sells can accomplish many objectives, butare primarily used to ensure the smoothcontinuation of a business after a potentiallydisruptive event, such as an owner'sretirement, incapacity, or death.

Also valuable estate planning tools, buy-sellscan provide for the orderly succession of afamily business, and for the liquidity neededfor payment of a deceased owner's estatesettlement costs and taxes. Further, ifstructured properly, a buy-sell can establishthe purchase price as the taxable value of anowner's business interest, avoidingunexpected estate tax consequences at theowner's death.

Buy-Sell Illustration

What is a buy-sell agreement?Buy-sell agreements are very importantplanning tools that can accomplish manythings for a business with two or more owners.Sometimes referred to as a prenuptial orpremarital agreement among businessowners, a business continuation agreement, astock purchase agreement, or a buyoutagreement, a buy-sell is a legally bindingcontract that establishes when, to whom, andat what price an owner, partner, orshareholder can sell his or her interest in abusiness.

A typical buy-sell allows a business entity orother business owners the opportunity topurchase a departing owner's businessinterest at a predetermined price. This allowsthe business and the remaining owners toprotect themselves from future adverseconsequences, such as disruption ofoperations, entity dissolution, or businessliquidation that might result if certain events,such as an owner's sudden incapacity or

Page 2 of 5, see disclaimer on final page

death should occur. This can also minimizethe possibility that the business will fall into thehands of outsiders.

The ability to fix the purchase price as thetaxable value of a business interest makesthis tool especially useful in estate planning.Agreeing to a purchase price while all partiesare alive minimizes the possibility of unfairtreatment to a deceased owner's heirs. And,the IRS' acceptance of this price as thetaxable value can help minimize estate taxeson the deceased owner's business interest.

Additionally, because funding for buy-sells istypically arranged when the buy-sell isexecuted, the possibility that funds will not beavailable when needed is minimized, and adeceased owner's estate can be provided withneeded liquidity for expenses and taxes.

Tip: Buy-sells are also used to give abusiness and co-owners the right to buy outan owner (force an unwilling owner to sell), orto give an owner the right to force thebusiness or co-owners to buy him or her out.

How does a buy-sell agreementwork?A buy-sell can be a separate agreement orcan be created by including buy-sellprovisions in a business' operating agreement.

A buy-sell must clearly identify the potentialbuyers, any restrictions and limitations, andthe conditions under which a sale will occur.Sale triggering events typically include:

• Death• Long-term disability• Retirement• Divorce• Personal insolvency or bankruptcy• Criminal conviction• Loss of professional license• Resignation or termination of employment

A buy-sell should set forth the purchase priceor a formula for determining the purchaseprice. Without establishing this price inadvance, lengthy disputes and lawsuits canarise at the time the ownership interest mustbe bought back.

Fixing the estate tax value of a businessinterest

One of the advantages of buy-sells is theability to fix the purchase price as the estatetax value of a deceased owner's businessinterest, which can help avoid future valuationproblems with the IRS. When using a buy-sellto set the estate tax value of a businessinterest, careful drafting is essential. To passmuster, all buy-sells must pass the followingfour-part test:

1. The estate must be obligated to sell thebusiness interest at the price set forth inthe buy-sell

2. The buy-sell must place certainrestrictions on lifetime transfers of thebusiness interest

3. The value of the business interest must befixed by, or determined from, the buy-sell

4. The buy-sell must be a bona fide businessarrangement, and not a transfer for lessthan adequate consideration

When the buy-sell involves family members, itmust also be proven that the transaction iscomparable to arms-length sales betweenunrelated persons, and was entered into for abona fide business purpose.

Caution: Determining the fair market value ofa business may require an independentbusiness valuator. The IRS can impose harshpenalties for understating the value of anasset for estate tax purposes.Financing the buyout

For a buy-sell to be successful, funds must beavailable to carry out the terms of the buy-sell.Without a funding plan in place, the buyer(s)may be forced to sell assets, take out loans, oreven file for bankruptcy.

There are several ways to fund a buy-sell,including:

• Cash• Borrowings• Installment sale• Self-canceling installment note• Private annuity• Stock redemption• Sale-leaseback• Appreciated property bailout• Deferred compensation• Life insurance• Disability insurance

Factors that generally influence the choice offunding method include:

• Business structure, size, and tax bracket• Number of owners, their ages, tax

brackets, and ownership percentages• Levels of cash or credit available to the

business or the owners• Type of buy-sell agreement

Depending upon the specific details, theremight be just one funding method that isappropriate, or there may be several fundingmethods that could be used.

Structuring buy-sells

Buy-sells can be structured to meet the needs

Page 3 of 5, see disclaimer on final page

of both the business and the owners, takinginto consideration tax consequences andindividual goals. There are four basicstructures for buy-sells, and somecombinations are possible. Very briefdescriptions of the four basic structures follow.

1. An entity purchase buy-sell obligates thebusiness to buy the interests of eachdeparting or deceased owner.

2. With a cross purchase buy-sell, eachowner agrees to buy a share of adeparting or deceased owner's interest.The business is not a party to this type ofbuy-sell.

3. A unilateral or one-way buy-sell is usedwhen only one owner is selling an interest,and is typically used in sole ownershipsituations where the owner is arranging tosell the entire business to a familymember or key employee.

4. A wait-and-see buy-sell is used when theparties are unsure whether the businessor the owners will buy the businessinterest. Typically, the business is giventhe first option, and if it does not exercisethe option, the remaining owners aregiven the opportunity. If the remainingowners do not exercise their option, thebusiness is obligated to buy the interest,just as with an entity purchase buy-sell.

Tip: It is not necessary that the same buy-sellapply to all the owners of a business.

Suitable clients• Business owners who do not want to be

forced to work with or share control of thebusiness with a stranger who buys aninterest from a departing owner

• Business owners who do not want to beforced to work with a spouse or other familymember of a deceased or divorcedco-owner

• Business owners who do not want to endup co-owning the business with abankruptcy trustee or creditor if a co-ownerexperiences personal financial difficulties

• Business owners who do not want theirheirs to inherit a business for which theycannot get a fair price

• Business owners who do not want toengage in pricing disputes with heirs ofdeceased co-owners

ExampleSteve and Jack are brothers who loved carsas teenagers. Steve could fix just aboutanything and Jack went to all the car showsand talked to anyone who would listen aboutthe new models.

As soon as they graduated college, Steve and

Jack borrowed some money and bought a cardealership. Over the years, they built a verysuccessful business--Steve ran the operationswhile Jack took charge of sales andmarketing.

While their business thrived, their personallives flourished as well--each marrying andhaving several children. But then, one day,Jack unexpectedly had a heart attack anddied. Jack's family was overwhelmed withshock and grief. After several weeks, Jack'swidow, Norma, came by Steve's office. Normawas very nervous--she needed to broach thesubject of her husband's interest in thedealership, but knew Steve was having adifficult time managing the business on hisown. Norma was having her own financialdifficulties, however, having a large mortgageto pay and two children in college. Shecouldn't put off this meeting, even if it resultedin tension and bad feelings.

To her delightful surprise, Norma soondiscovered how much foresight her husbandand brother-in-law possessed. They hadexecuted a buy-sell agreement many yearsago, just in case such an unfortunate eventshould occur, and financed the agreementwith life insurance policies on each other'slives. Steve was in the process of claiming theproceeds and would pay Norma theagreed-upon purchase price.

Norma received her rightful share of thebusiness, in cash, with which she was able tomeet her family's needs. Steve was able tocontinue the business with no interference.And though it wasn't quite the same, he hireda sales and marketing manager to take overhis brother's duties, and the dealershipcontinued to operate successfully.

Advantages• Assures continuation of a business• Assures a smooth transition of a business• May prevent loss of entity status due to

restrictions on transfers of interests (Scorporations and limited liabilitycompanies)

• Provides assurance to creditors,customers, and employees

• Guarantees a buyer for a departing owner'sinterest

• Can prevent outsiders from gaining controlof business

• Establishes a taxable value in advance,minimizing estate taxes and potentialvaluation conflicts with IRS at time ofowner's death

• Protects heirs from unfair treatment• Ensures estate liquidity

Page 4 of 5, see disclaimer on final page

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2020Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2020Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2020

Disadvantages• Depending on the type of buy-sell, there

could be adverse income taxconsequences to the business and/or theowners

• Meticulous drafting is required--improperly

• Valuations may need to be updated fromtime to time

• If funded with insurance, care must betaken to provide continuing coverage

drafted buy-sells can result in unintendedconsequences and tax code violations

This information, developed by an independent third party, has been obtained from sourcesconsidered to be reliable, but Raymond James Financial Services, Inc. does not guarantee thatthe foregoing material is accurate or complete. This information is not a complete summary orstatement of all available data necessary for making an investment decision and does notconstitute a recommendation. The information contained in this report does not purport to be acomplete description of the securities, markets, or developments referred to in this material. Thisinformation is not intended as a solicitation or an offer to buy or sell any security referred toherein. Investments mentioned may not be suitable for all investors. The material is general innature. Past performance may not be indicative of future results. Raymond James FinancialServices, Inc. does not provide advice on tax, legal or mortgage issues. These matters should bediscussed with the appropriate professional.

Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC .Investment advisory services are offered through Raymond James Financial Services Advisors,Inc. Beachside Wealth Partners is not a registered broker/dealer and is independent of RaymondJames Financial Services.

Page 5 of 5