Buy-Sell Ageements: Does Yours Still Make Sense?
It's like breathing in and breathing out: if your private company has several owners, experts will automatically recommend you sign a buy-sell agreement. But unless you're careful, you can run into problems, warns Allan Landau, a senior partner with the Boston law firm Sherburne, Powers & Needham, PC. He reports spending as much time dismantling buy-sell agreements as he does setting them up.
How can that be possible? "Difficulties arise if one of the owners has adult children working in the business," explains Landau. "He or she may realize, 'If I die and the buy-sell agreement works as planned -- with insurance paying for the purchase of my stock -- my children will get cash, but they will no longer be shareholders in the business.' "
That could be a disaster for a child who really wants to be a part of the company over the long run. Says Landau, "It doesn't even matter if your child is a key player. You and your partner are basically playing Russian roulette to see who dies first and who winds up with the business."
Fortunately, you can eradicate a buy-sell agreement quite simply. "All you need is a signed and witnessed document that specifies that the buy-sell agreement will be terminated as of a specific date," says Landau.
As soon as the buy-sell is eliminated, ownership of your company returns to its preagreement state. But don't stop there. Landau advises you to replace the buy-sell agreement with an estate-planning agreement that works like this:
1. As the shareholder whose children are in the business, you purchase the life insurance that originally supported the buy-sell agreement and put it into an irrevocable life-insurance trust. Pay for that purchase with personal savings or by borrowing against the cash value of the original policy, if any has accumulated. The proceeds of the irrevocable trust wind up estate-tax-free if you survive three years after the transfer.
2. Upon your death, the trust established for your children may use the proceeds of the insurance to purchase the stock from your estate.
3. According to a stock-restriction agreement executed at the time you terminate the buy-sell agreement, the stock the children purchase or inherit may not include voting rights during the lifetime of any other first-generation owner, which ensures his or her management control. The children get voting rights only after the other owner's death and only if they are employed by the business.
The advantage of such an arrangement is its flexibility. "If you've got two owners with children in the business, you can set these plans up on both sides. Or if only one set of kids is involved, you can have a traditional buy-sell agreement on one side and this type of plan on the other," says Landau.
Most important: consult an estate-planning lawyer to determine which combination of strategies will work best for you. You may determine that leaving your existing buy-sell agreement in place still makes sense.