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The owners of most small, closely-held businesses negotiate and sign some form of an “Owner’s Agreement.” An important part of such Agreements is the “Buy-Sell” provisions. These are often some of the most difficult to negotiate. The gist of the buy-sell part of the Owners’ Agreement is to establish the rules for what happens if one of the owners exits the business because of
Because the business is closely-held, the owners who remain with the business do not want to have an unpleasant surprise when an owner sells his or her ownership shares to a third-party stranger, or when, because of divorce or death, an ex-spouse or widow/widower is sitting in the boardroom, or when a trustee/creditors’ representative show up after being appointed during a personal bankruptcy, etc.
The buy-sell provisions attempt to solve these problems in advance and generally cover who can buy the ownership interests, under what condition and — importantly — at what cost. If the owners cannot agree at first on the price, then, usually a formula is agreed to or a mechanism for allowing the issue to be decided by business valuation professionals. The general idea is to ensure that the business can continue to operate smoothly while giving the owner who is exiting a fair value for their ownership interests.
Liquidity is, however, a problem that must be solved. As an example, a buy-sell provision might ban the sale of ownership interests to any third-party that is not “acceptable” to the other owners, providing that, after some amount of time or some number of candidates proffered, the other owners would be forced to buy out the ownership interests in question. In that situation, liquidity becomes a potential issue. Suppose the agreed buyout formula required payment by the company of $500,000. The company might be hard-pressed to come up with the payment amount.
This, then, is the purpose of buy-sell insurance. It is also often called “Business Continuity Insurance.” Generally, the insurance product is a combination of disability and life insurance and is not one policy, but several. The greater the number of owners, the greater the number of individual policies needed.
Buy-sell insurance can be structured to cover the first three problems addressed by the buy-sell provisions: death, disability and retirement. But, generally, buy-sell insurance will not cover problems potentially created by divorce or a personal bankruptcy. (As for those, extended payment plans or deferred sales are possible solutions along with strict separation of voting rights and dividend/profit rights).
In any event, typically, the buy-sell insurance is purchased, paid for, and owned by the company. This is because the purpose would be defeated if an individual owner let personal policies lapse by failing to pay the premiums. However, the specific arrangement depends on how the buy-sell is structured and there are tax consequences to be considered and evaluated by competent tax professionals.
Contact the Business Attorneys at Revision Legal
For more information, contact the experienced Business Lawyers at Revision Legal. You can contact us through the form on this page or call (855) 473-8474.
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