How to Successfully Exit a Business
Owners invest large amounts of time, energy, and money to grow their businesses into what may become one of their largest assets. The business provides income, jobs for their employees and it contributes to the community. With proper planning, a business owner can address the three ways to exit a business. Succession plans should not only cover retirement, but death and disability as well.
Buy-Sell Arrangements
A buy-sell arrangement is a contract that identifies a buyer, sets a fair price for the buy out, and obligates the buyer to buy and the seller to sell at that price. When the arrangement is funded with life insurance, buyers can be confident that some or all the money needed to complete the buy out will be available when the owner-seller retires or dies prematurely.
There are many ways to set up business continuation plans; the strategies differ on who buys out whom:
Unilateral Buy-Sell
This is a buy-out arrangement between a business owner and a third-party. At an owner’s death or departure, the third-party must buy his or her interest based on the terms of a written agreement between them. To fund the buy-out, the third-party buys a life insurance policy on the life of the owner.
Cross Purchase
There are two types of cross purchase buy-sell arrangements.
In a Traditional Arrangement, at an owner’s death or departure, the remaining owners must buy his or her interest based on the terms of a written agreement between the owners. To fund the buy-out, each owner purchases a life insurance policy on the life of each of the other owners.
In a trusteed arrangement, the owners set up a trust and the trust owns a single policy on each owner. When an owner dies, the trustee receives the life insurance proceeds and buys the business interest from the decedent’s family.
Entity Purchase
This is a type of business purchase plan between a business and one or more of its owners. If the business is a corporation, it is known as a stock redemption agreement. At an owner’s death or departure, the business must buy his or her interest based on the terms of a written agreement between the business and owner. To fund the buy-out, the business buys a life insurance policy on the life of each owner.
Wait-and-See Buy-Sell
In a wait-and-see buy-sell arrangement, the business owners wait until the death or departure of an owner to decide who—the business or the co-owners—will buy the business interest.
No-Sell Buy Sell
A no-sell buy-sell agreement is an alternative to selling a business interest when an owner dies. The owner leaves his or her interest in the business to a trust that is managed by the remaining owners for the benefit of the decedent’s family. The remaining owners, not the decedent’s family, vote the stock held in the trust but the family can share in the business’ future growth.
Transferring a Family Business
Many family businesses use a buy-sell arrangement to transfer the business to family members active in the business, but it may not be the best way to approach this problem.
An alternative is “Gifting the Family Business,” where clients use their will or living trust to leave the business to those children who are involved in the business. If your clients are insurable, they may be able to replace the value of the business with a life insurance policy that names the surviving spouse as beneficiary. When the first spouse dies, the surviving spouse can invest the insurance proceeds to provide income. After both die, the children who didn’t inherit the business receive the remaining insurance proceeds to “equalize” the division of their parents’ estates.
Another strategy, called “Estate Equalization,” uses life insurance to enable clients to make sure the children working in the business get the business; other children receive cash to “equalize” the division of the estate.