Is a One-Way Buy-Sell Agreement right for your business?

Steven M. Lutz

Author: Steven M. Lutz

POST DATE: 3.14.16
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Being the sole owner of a business – whether you are operating as a proprietorship, one-owner corporation, or LLC – creates special issues relating to business succession and planning. Who will take over your business when you elect to retire or if you meet an early death? The One-Way Buy-Sell Agreement offers a possible solution to these issues.

The Problems

As the sole owner of your business, you have likely created something worth maintaining after you decide to retire or in the event you meet an early death. Without a co-owner to purchase your interest you may lose significant value and customer goodwill developed from your years of hard work.  You and your family may also stand to lose an important source of income. Faithful, long-term, employees may be suddenly out of work. Your business creditors may have pending claims to be handled, or may be unwilling to extend additional credit to your business absent your continued presence. If the business is to be transferred to your heirs according to your estate plan, your heirs may not be prepared to run your business. Many small businesses simply do not outlast their founder, no matter how strong the market presence, because of a lack of appropriate business succession planning.

A Potential Solution

If you can identify a potential purchaser – ideally from among your valued employees – a simplified type of “buy-sell agreement” typically used by businesses with multiple owners could be used to facilitate your business succession plan.  In this scenario, you would contract to sell – and the purchaser would contract to purchase – your business ownership interest upon the occurrence of a specified event, like retirement, death, or disability. The purchase price can either be a fixed value, or you can simply establish a formula for calculating the purchase price in the future. The agreement can also attempt to limit the purchaser’s exposure to existing business debts and obligations. Your executor could use cash from the sale of your business interest to payoff business obligations and, if applicable, other costs, taxes, and administrative expenses of your estate if necessary. The balance of the proceeds could then be distributed under the terms of your estate plan to your estate beneficiaries.

Funding the One-Way Buy-Sell

A purchaser under a One-Way Buy-Sell Agreement typically purchases a life insurance policy on your life in an amount sufficient to meet the purchase price payment amount provided for in the agreement. The business purchaser would be the owner and beneficiary of that policy. The purchaser would likely be required by the One-Way Buy-Sell Agreement to maintain that policy and to notify you prior to exercising any policy rights that might affect its value. As a result, the agreement might limit your ability to dispose or otherwise encumber the business assets without the purchaser’s prior consent. If the purchaser is also obligated to purchase the business if you become disabled, the purchaser will likely desire to insure this obligation as well through disability insurance. If the triggering event is your retirement and not death, then the purchase price could be paid out over time, either in regular installments from business cash flow, or as a percentage of business income over time. The purchaser could also seek financing to pay off the purchase price in a lump sum. All of these terms would be negotiated between you and the purchaser.

Quick Summary of the Transaction

  1. The owner of a business enters into a One-Way Buy-Sell Agreement with a non-owner under which the owner agrees to sell, and the non-owner agrees to purchase, the business upon the owner’s death (and possibly other triggering events), and at a price specified in the agreement.
  2. The non-owner purchases life insurance on the life of the owner and names himself/herself as the beneficiary to ensure that he/she will have the funds to purchase the business at the owner’s death.
  3. When the owner dies, the non-owner receives the death proceeds of the policy.
  4. The non-owner uses the death proceeds to carry out his/her purchase obligation under the “one-way” buy-sell agreement.
  5. The owner’s estate transfers ownership of the business interest to the non-owner who becomes the owner.

Conclusion

A One-Way Buy-Sell Agreement can be an attractive option to extend the life of your one-owner business in the event you retire, die or become disabled. The challenge comes in finding a willing purchaser with a significant connection to the business – someone you trust to maintain the life of your business in the future and who is willing to take on the related obligations.

For more information or for assistance in creating a One-Way Buy-Sell Agreement for your business or to discuss other issues related to your business operations or succession planning, please contact us.

To learn more about Steve and his practice, please visit his profile.