Why a Co-Owned Business Needs a Buy-Sell Agreement

April 17, 2024
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As a co-owner of a business, you must consider the structural and legal frameworks that are crucial to ensuring the stability and continuity of your investment. This is a smart approach whether it’s an existing venture, a new enterprise you’re founding, or a company you’re considering investing capital.

One strategic legal framework is a buy-sell agreement. This can be an essential tool for managing ownership transitions smoothly and efficiently.

Why Consider a Buy-Sell Agreement?

A buy-sell agreement can transform your business ownership into a more liquid asset, prevent unwanted changes in ownership, and save on taxes while avoiding complications with the IRS. Essentially, it’s a contract that predetermines how ownership interests are bought and sold under certain conditions. It provides a clear path forward during times of transition.

Types of Buy-Sell Agreements

There are two primary types of buy-sell agreements. Both of these agreements aim to ensure there’s a buyer for every co-owner’s interest when needed. They can also restrict unilateral transfer of ownership and secure favorable tax results.

  1. Cross-purchase agreement. This is an arrangement among co-owners where, upon a triggering event (such as death or disability), the remaining co-owners must buy out the departing owner’s interest.
  2. Redemption agreement. Here, upon a similar triggering event, the business itself contracts to buy out the departing owner’s interest.

Triggering Events and Valuation

Examples of triggering events include death, disability, retirement, or even simply a desire to exit the business. These should be properly defined in the agreement. Specifying an acceptable method for valuing ownership interests is vital, as is ensuring that the IRS respects the valuation method for tax purposes.

Funding the Agreement

You will likely want to use life insurance policies to fund the buyouts. They can provide the necessary liquidity when the most common triggering event occurs, such as the death of a co-owner. This approach can also offer significant tax advantages.

Benefits for You and Your Heirs

Implementing a buy-sell agreement offers certainty for your heirs, potentially avoiding market absence for your ownership interest and disputes over valuation for estate tax purposes. It establishes an agreed-upon method for selling your interest by providing liquidity and possibly eliminating estate tax hassles.

Creating a Buy-Sell Agreement

Given the complexity and the significant implications for your business and personal estates, setting up a buy-sell agreement is not a do-it-yourself project. To tailor an agreement that fits your specific situation and goals, professional legal and tax advice is crucial.

If you want to discuss buy-sell agreements or any other business planning needs, contact Illumination Wealth today to schedule an introductory consultation with one of our leading advisors.