This is a case study about a company that did not have a buy and sell agreement in place. The business has grown substantially. The owners were concerned about the growth of the company, sacrificing larger salaries to invest and grow their business.
The accountant recognized that there was a problem if there was a termination of a partner, and referred me to his clients to help educate them on estate and business planning, and also to help them design a buy and sell agreement.
Scenario:
Bill and Sam started a very successful manufacturing company. They produced the assemblies for hard drives.
They are a C corporation and have scaled tahe business from four full time workers to about 34 employees. Their client base has grown from just a few to a few dozen over the years.
One Page Issue(s) (With our team we identified these issues)
- The business has never been appraised so there is a question of the value of the company and estate.
- Both partners have families and larger personal liabilities than when they started.
- They have invested their earnings into the business and don’t have a retirement plan.
- They don’t have a binding buy and sell agreement, nor a method of funding the liability.
- The owners are expecting the exemption credit to lower which will expose them to death taxes.
- Neither partner has done any estate planning, other than simple wills.
- Retaining the key person in the firm who has the relationship with the customers, vendors and key contacts. Because he basically runs the company, the owners take a lot of time off. They are concerned that the competition may try to recruit him. If lost, it would have a major impact on the company.
Major issues and immediate concerns:
- Potential fire sale of the firm if there is not a “planned design for buyout”
- Uncertainty and instability for the employees, especially the key people in the firm.
- The possibility of the deceased partners family running the business with the surviving partner, leading to inexperienced leadership.
- Lack of liquity to pay the taxes assessed on the value of the business and other administration costs. Without the valuation, it was a best guess estimate, jeopardizing accurate estate planning.
- Business valuation disagreements, especially IRS litigation.
- Lack of market for the business.
- The loss of income for the family.
- Lending from the banks could be cut off after the death of one of the owners. No assurances that loans would be immediately available upon an owners termination. A concern that any new loans in the future may have convenants that credit lines would be redeemed upon a partners termination unless there was a valid buy and sell agreement.
- Stress on the business’ cash flow or credit line as a result of the surviving owner trying to purchase the deceased partner’s share.
- The possibility of losing their key person to a competitor would be a significant loss to the firm.
One Page Solution
The most critical issues to solve now :
- Complete a Buy and Sell Agreement with funding/ both life insurance and disability insurance
- A Certified appraisal to be done
- Create strategies to keep the key person with the company
- Start the process of personal estate planning for each partner
There were other issues, but we all felt the buy and sell agreement was the most important at this point.
One Page Solutions For Buy and Sell Agreement:
- Cross purchase buy and sell agreement funded with cross owned permanent life insurance
- The insureds were about the same age
- They were both in great health
- Premiums were about equal in cost, and the corporation would bonus the premium to the owners
- Since the owners willl sell in the future, having the increased stepped up in basis would save taxes, as the partners plan on selling in the future.
- Also wanted the insurance company to define full disability through the contract definition.
One Page Solution FOR KEY PERSON:
A CEEP for the key person (Corporate Executive Equity Plan); For Key Person
- Cash Equity for retirement
- Tax free death benefit for family
- Limited contribution by employee-basically paid in full by employer
- Tax-free income at retirement- Will create about $200,000 tax free for 20 years at 66
There was a vesting schedule designed for the employee for 10 years. If he stayed he would have a much richer benefit than his 401k would provide
- Non-compete, Non-recruiting and solicitation of employees of the firm, and Non-disclosure agreement to be executed by key person
Estate Planning:
Currently, working with the attorney on new wills, trusts, and an irrevocable trust for life insurance. There are some other things we are considering with real estate owned outside the state, such as LLC, AND inter vious trusts.
Triggers: In the agreement we established the major triggers: death, disability, termination, retirement, divorce, bankruptcy. We decided to use a disability income policy to fund that part of the plan. We also wanted to have the definition of disability decided by the insurance company.
As we move forward we are reviewing other issues yearly. Also, forming the team with the attorney, CPA, and others was instrumental in accomplishing the results.
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