Why Every Business Owner’s Estate Plan Needs a Buy-Sell Agreement
Posted by Cheryl A. Jankowski on October 24, 2024
If you have an ownership stake in a closely held or family-owned business, a buy-sell agreement is a vital part of your estate plan. This agreement ensures an orderly transfer of ownership when a "triggering event" occurs, such as death, disability, divorce, or retirement, by permitting or requiring the remaining owners or the business itself to purchase the departing owner's interest. Life insurance is often used to fund the buyout, and regular reviews of the agreement are essential to keep it aligned with current needs and business value.
Keep the Valuation Provision Up to Date
The valuation provision—how the purchase price is determined—is a critical part of any buy-sell agreement. Regularly updating this provision is essential to reflect the current value of your business, especially as the federal gift and estate tax exemption may be reduced in 2026. Valuation methods generally fall into three categories:
- Independent Appraisal by one or more business valuation experts for accurate and fair pricing.
- Formula-Based Valuations, such as book value or a multiple of earnings, which may be affected by changing circumstances.
- Negotiated Price, allowing owners to agree on a value, with an appraisal as a backup if they cannot reach a consensus.
Independent appraisals typically offer the most accuracy, while formulas can become outdated. A negotiated price may seem ideal but can be impractical under stressful conditions; including an appraisal backup can help ensure a fair outcome.
Choosing Between Redemption and Cross-Purchase
The structure of a buy-sell agreement has important tax and estate planning implications. Most agreements are structured as either a redemption agreement, where the business itself buys the departing owner's interest, or a cross-purchase agreement, where remaining owners make the purchase. While redemption agreements may have tax consequences, cross-purchase agreements can be cumbersome, especially if multiple owners are involved, as each owner must take out life insurance policies on every other owner.
Benefits of a Buy-Sell Agreement
A well-crafted buy-sell agreement provides numerous advantages. It helps keep ownership within the family, creates a market for otherwise hard-to-sell business interests, and offers liquidity to cover estate taxes and other expenses. Additionally, the agreement can sometimes establish the value of a business interest for estate tax purposes. Reach out to us for input into your buy-sell agreement to help protect your business’s legacy for future generations.
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Cheryl has extensive experience working with business owners and individuals on minimizing taxes, with a focus on succession planning. With a thoughtful approach, Cheryl helps clients explore their long-term goals and plan accordingly. Leveraging Cheryl’s expertise in this area, the goal is to implement plans that achieve the wishes of the client and provide for tax-efficient transitions. Cheryl’s passion for working with corporations and individuals has allowed her to become a trusted business advisor. She has worked with clients not only in the Western New York region but also throughout the country. The breadth of this experience has allowed her to collaborate with other professional advisors to ensure that plans are flexible and innovative in the ever-changing world in which we live. Cheryl started her career with the Firm in 1991 and rejoined in 2019 adding additional strength to the tremendous talent of the Lumsden McCormick tax team.