Buy And Sell Agreements and The Use of an LLC!

By Thomas J. Perrone, CLU, CIC

A much-overlooked area of planning for small business owners is their buy and sell planning. A business is fluid and forever changes its financial position. In many cases industry changes and markets affect the value of the company. Because of the ongoing changes in business value and growth pattern, the buy and sell agreement should be reviewed more than periodically. I suggest the professionals and parties to the agreement review the value and the elements of the buy and sell, yearly. There are two parts of the review.

The agreement should be reviewed for the “triggers” which will set in motion the BSA. There are many BSA that have been executed which only deal with the death, disability, and retirement of the owners. Some other triggers would be bankruptcy, divorce, non-voluntary termination, voluntary termination.

The Funding:

This area strives to make sure the parties are sufficiently liquid when needed to fulfill the obligation of purchasing the ownership value.

Cross purchase: Members buy and own life insurance on other members. For example, if you had four owners, twelve policies would be in force (3×4).

Endorsement: The Company purchases and owns life insurance on the parties to the agreement. At their death, the company receives the proceeds and purchases the value from the deceased’s estate.

The endorsement method is simple, as the company will purchase life insurance on the party to the agreement. For example, if there are only four owners, the company will purchase life insurance on each of them, or four policies. Upon the purchase of the decedent’s equity, the surviving owners will not have an increase in business cost basis.

Using the LLC

The LLC is set up to purchase life insurance policies on each owner. Upon their death, the LLC collects the proceeds and purchases the ownership for the surviving owners.

There is no “transfer for value,” as partnerships are an exemption for the transfer of value. The remaining owners have a cost basis increase.