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Buy-sell agreements – Part 3

buy-and-sell agreements

In the previous 2 articles, we touched base on the overview of the importance of buy-and-sell agreements as well as the structuring of the life policies that form part of the agreement. This week we will answer some of the most commonly asked questions pertaining to buy-and-sell agreements.

Can a co-owner’s personal bankruptcy affect the business?

In the worst-case scenario, a bankruptcy trustee could liquidate the business (i.e. sell all of its assets) and take half of the proceeds to pay the bankrupt owner’s debts. To prevent a business from getting tied up in bankruptcy court, the owners can sign a buy-and-sell or buyout agreement that requires a co-owner who faces bankruptcy to notify other co-owners before filing. Under the terms of this agreement, this becomes an automatic offer to sell the bankrupt owner’s interest back to the other owners. The buyout money goes to the bankruptcy trustee and the business can proceed without difficulty.

Can a buyout agreement be used to avoid estate taxes?

A buyout agreement can successfully be used to lower estate taxes in intergenerational businesses – businesses where at least one co-owner plans to leave the interest to heirs who will remain active in the business. This can help a family business owner pass the business on to children or other relatives without burdening them with unnecessary estate taxes caused by an aggressive value of the business. The key to estate planning is choosing a conservative price or valuation formula for the business in the buyout agreement. The result is to legally set the value of the ownership at an amount considerably lower than its sales value at the time of death.

What’s the best way to value a company when an owner is being bought out?

You can hire a professional valuator or use a valuation formula to calculate a price using financial statements from one or more financial years. The problem however is usually that at the time of the sale, co-owners are divided between the different valuation methods, which can also produce vastly different end results. For that reason, it is helpful to specify a way to value the company in advance in their buy-sell agreement. This gives the owners a chance to discuss and vote on how a reasonable price for the company should be calculated. The fact that a sound method was agreed to beforehand can go a long way to reducing conflict when the time for buyout comes.

What happens if a company needs to, but can’t afford to buy out one of its owners?

Requiring an immediate 100% lump-sum cash payout can prevent even the most successful company from buying back an owner’s interest. That’s why having flexible payment terms built into a buy-and-sell agreement, signed in advance, can assist greatly in overcoming this obstacle. For instance, a buyout agreement can provide for a down payment of 1/4 to 1/3 of the buyout price followed by installment payments for three to five years at a reasonable rate of interest.

If a co-owner of a business divorces, can the former spouse ask for a part of the business?

Short answer. Yes. But dependent on the nature of their marriage contract. If they are married in community of property, for instance, all earnings during marriage and all property acquired with those earnings are considered community property, owned equally by husband and wife.

How does one ensure that you qualify for an Estate duty exemption?

Without going into any detail, an exemption exists in the Estate Duty Act to prevent estate duty from being levied in the deceased estate on the policies used for buy-and-sell, if

  • The policy was taken out by a person who at the date of death of the deceased, was a partner / co-shareholder / co-member of the deceased.
  • The policy must have been taken out for the purposes of a buy-and-sell agreement, and
  • No premium on the policy must have been paid or borne by the deceased.
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