On February 3rd the CyFair Houston Chamber of Commerce will host a roundtable meeting on business succession. The session is being hosted by the Business Development Networking Committee. You can register for the session by clicking here. Why should you attend?
Did You Know?
Seven in ten small business owners have thought about who would run the business in their absence, but only 25 percent have formal retirement succession plans and only 35 percent have formal continuation plans in the event of their deaths.1
This means that 65-75 percent of small business owners do not have any type of succession plan in place should they retire, become disabled or die.
What is a Buy-Sell Agreement?
A buy-sell agreement is a written legal contract that specifies what happens to the business interest in the event that the owner dies, becomes disabled, or retires from the business. It can help prepare the business owner for the continuation of their company and provide financial security for their family.
When fully funded, the buy-sell agreement will:
- Establish a ready market to purchase a business interest
- Establish a value for the purchase price of the business interest
- Identify the future buyer(s)—typically co-owners or key employees
- Identify the events that would trigger the buy-sell agreement
- Create a legal obligation for all parties involved
- Provide a source of funds necessary to make the buy-sell arrangement effective
How it works:
There are three different approaches that can be taken to structure a buy-sell agreement. These are commonly referred to as:
- Cross Purchase
- Entity Purchase
The appropriate method depends upon several factors, such as:
- The number of owners
- The number of buyers
- Whether the buyers are family members, co-owners, or outsiders
- The legal structure of the business entity
- Tax consequences
How Much is the Business Worth?
Determining the value of the business is a crucial part of the business succession planning process. Most business owners think they know the value of their business, but are surprised at the actual value when all the relevant factors are analyzed. There are several criteria that come into play when determining the value of a business. These are:
- The book value of the company
- Company’s earning capacity
- Recent sale of company stock
- Company’s ability to pay dividends in the future
- Business performance comparison to similar companies
- Existence of goodwill
- History and nature of the business
- Economic outlook
Business valuation is also used to determine the tax basis for the seller and buyer. If the business is sold by the beneficiaries after the owner’s death, typically no income tax is due upon the sale. This can be done when the business interest receives a step-up in basis to the date of the death value.
How is a Buy-Sell Agreement Funded?
A buy-sell agreement, on its own, is not effective unless the agreement is also properly funded. Permanent life and disability buyout insurance policies are the best ways to fund buy-sell agreements. Business cash flow, cash reserves, or borrowing may also be used, but they are typically insufficient and expensive solutions. They are more suited for supplementary funding.
There are many advantages to both the departing and surviving owners when funding the buy-sell agreement and each has its own unique value.
Advantages to the departing owner(s) include:
- Provides money to help meet ongoing expenses
- Converts business wealth to personal wealth to pay for retirement
- Payments are prompt
- Sets a fair and reasonable price
- There is as little conflict as possible
Advantages to the surviving owner(s) include:
- Prompt exit of deceased’s heirs
- Continuity of management
- Stability for employees, vendors and clients
- Establishes a fair and reasonable price
- There is as little conflict as possible
If you have an interest in learning more about how to sell your business when you retire, die or become disabled you are invited to the Peer Coaching Session on February 3rd, 2015 at the CyFair Houston Chamber of Commerce. For more details click here.
1 LIMRA Small Business Owner Report: 2009