Buy-Sell Agreements Archives - Randel Law, Inc., Your Business and Succession Planning Lawyer as well as Corporate Transparency Compliance

Buy-Sell Agreements Funded by Life Insurance

October 31, 2024 By Rick Randel

Rick Randel Mergers and Acquisitions and Succession Plans for Financial Advisers, File Beneficial Ownership Information Reports with FinCEN under the Corporate Transparency Act

You may have seen or heard references to a recent United States Supreme Court case called Connelly v. United States. I’ve seen blurbs implying that the case invalidates buy-sell agreements or life insurance funding of buy-sell agreements.

Nothing could be further from the truth. All the court said is that the value of life insurance proceeds is counted toward valuing the company for estate tax purposes, and the company’s obligation to purchase those shares is not an offsetting liability. A significant decision by all means, but not one that invalidates life insurance funding.

A brief explanation:

When a person dies, if their estate is worth over $13,610,000, it’s subject to a 40% estate tax. If the deceased owned stock in a company, the value of that stock is counted toward the value of the estate. The more the company is worth, the more the stock is worth.

What the Supreme Court said in Connelly is that if the company held life insurance on the deceased, the proceeds of the life insurance are counted toward the value of the company, but the company’s obligation to buy the person’s shares is not counted as an offsetting liability.

So buy-sell agreements are still valid, and life insurance to fund buy-sell agreements is still valid. The issue is that in some situations, a buy-sell agreement funded by life insurance could trigger or increase the amount of estate tax that is paid.

Connelly only applies to cases where the estate of a deceased shareholder is so large as to trigger the estate tax. From now through 12/31/25, that amount is $13,610,000. Even though that amount will probably go down after 12/31/25, Connelly will still only apply to a small subset of buy-sell agreements.

Also, Connelly only applies where the company is obligated to purchase the shares (sometimes called a “redemption”). It does not apply where the other shareholder(s) are required to buy the shares (a “cross-purchase”). In that case it’s the shareholders who take out insurance on each other, so the insurance proceeds are not counted as an asset of the company in determining the value of the shares.

Therefore, high net worth business owners whose buy-sell agreement calls for the company to buy the shares should consult with their tax and estate planning advisors about switching to a cross-purchase arrangement where the other shareholders buy the shares. Let me know if you need an introduction or would like my help in working with your other advisors to design a solution.

Thanks,

Rick Randel

This post is not intended and should not be relied upon as legal or tax advice pertaining to any specific matter. You are encouraged to seek competent legal and tax counsel before proceeding with any transaction involving any of the matters discussed above.

Is Now the Time?

April 8, 2020 By Rick Randel

My financial advisor friends and I never cease to be amazed at how many business owners don’t have a Buy-Sell Agreement. It’s like going out in the rain without an umbrella. Business owners know they should have a Buy-Sell Agreement but they procrastinate. Partly because they’re too busy, partly because they’re scared of the cost, and also maybe because they don’t want to face their own mortality. Well . . .

Is now the time?

One thing this pandemic has taught us is that we should always have our affairs in order and a plan to deal with contingencies.

So maybe now’s the time to finally do your Buy-Sell Agreement. Do you really want to find yourself in business with your late partner’s spouse? (Or your divorced partner’s ex-spouse?). Do you want your spouse to have to run your half of the business after you’re gone? Or would you rather he or she get bought out by your partner(s)?

A Buy-Sell Agreement can also help you obtain liquidity from your investment in your business, as I described in my previous post Building Liquidity Into Your Buy-Sell.

Or maybe you’re a solo owner with no partners, so a Buy-Sell Agreement doesn’t make sense. There are still many ways you can protect your business and your family should something happen to you. I call it the “Hit by a Bus Plan” (although maybe I should change the title to the “Hit by COVID-19 Plan”). This plan involves interim operating instructions for whoever has to run the business during your absence, transition instructions for your spouse, a salary continuation plan for your family to continue receiving money from the business to pay their expenses, and a key employee retention plan, which in some cases can involve a key employee buying the business from your spouse after you’re gone. For more information about the Hit by a Bus Plan, click here.

Maybe now’s the time to finally adopt a Hit by a Bus Plan to protect your business, your employees, and your family.

Feel free to contact me or your legal adviser if you feel like now’s the time to finally do your Buy-Sell Agreement or Hit by a Bus Plan. Or forward this email to a business owner you know, who might find it helpful. Best wishes and stay healthy!

This article is not intended and should not be relied upon as legal or tax advice pertaining to any specific matter. You are encouraged to seek competent legal and tax counsel before proceeding with any transaction involving any of the matters discussed above.

Can You “Trust” Your Buy-Sell Agreement?

September 14, 2019 By Rick Randel

As many of you know, buy-sell agreements restrict ownership to a small group of owners who know each other and have decided they can do business together. They allow the other owners to buy the shares of an owner who experiences a “triggering event” such as death or divorce.

As many of you also know, many business owners put their shares into their revocable living trust. Which raises the question, what happens upon a triggering event to an owner whose shares are held in a trust?

The typical buy-sell agreement fails to address this situation. I have long suspected the other owners may find themselves unable to buy him or her out.

A recent court decision confirmed my suspicion. A partner whose shares were held in a trust died. The other partners invoked their buy-out rights, but the successor trustee refused to sell. The other partners sued. The court held that the actual partner was the trust, not the trustee. Therefore, even though the individual had died, the partner itself (the trust) didn’t die, and the buy-out rights of the other partners were not triggered. The successor trustee was allowed to continue owning the deceased partner’s shares, despite the other partners’ desire to buy him out. (Han v. Hallberg, 35 Cal.App.5th 621 (2019))

While Han v. Hallberg dealt with a partnership and not an LLC or corporation, a court would likely reach the same result in the corporate or LLC context. The vast majority of buy-sell agreements I have seen do not address what happens when shares or membership interests are held in a trust. A good buy-sell agreement should say that for the purpose of triggering events, the term “shareholder” (or member or partner) refers to the person who is the true underlying owner of the shares, i.e. the person who is active in the business and who the other owners consider to be their “partner”, even if the shares are held in a trust. So a triggering event that happens to that actual person triggers the others’ buy-out rights.

Feel free to contact me if you would like me to take a look at your own or a client’s buy-sell agreement and see if it adequately addresses what happens when shares are held in a trust. If it doesn’t, adding that coverage is a simple fix.

The Secret to Protecting Your Intellectual Property

August 28, 2018 By Rick Randel

This is a true story. Only the names have been changed. My client (let’s call her Karina) had negotiated a deal with the owner of another company (lets call him Phil) to acquire Phil’s company. During due diligence we discovered that Phil’s company didn’t own the code to its own website. Considering the business was an online store, the code to the website (a form of intellectual property or IP) was a vital assets.

When we pointed this out to Phil, his reaction was “That’s crazy. Of course we own it. We paid for it.” But he had neglected to put a “work for hire” clause in the contract with the developer. So he didn’t own the code. This nearly killed the deal. There was no way we were going to complete the purchase without getting ownership of the core IP. The deal was put on hold for a month while Phil negotiated with the developer to acquire ownership of the code. Lord knows how much more he had to pay the guy. And he almost lost the deal. He was lucky Karina didn’t walk.

The same thing would’ve happened if Karina were an angel or VC about to invest in the company. One of the main things they do is confirm the company owns the IP.

The lesson is, when you or your client hire service providers to create any intellectual property (basically any work product or deliverable), make sure the contract states that the company owns any IP the person creates. Of course the contract should also require them to keep company information confidential. This should be part of the standard onboarding process for all employees and contractors.

That way when the company receives a due diligence list from a potential buyer or investor, it’s an easy matter to just send them copies of the contracts all the service providers signed, so the buyer/investor can see they own their IP (and that they are well organized and professional).

Feel free to contact me if you have any questions.

Write your own Business Continuity Plan

May 19, 2018 By Rick Randel

You may remember my recent post about the Hit by a Bus Plan. The Hit by a Bus Plan helps owners stop worrying whether their business will continue and their family will be protected if something should suddenly take them out of the picture.

Well, business owners have to plan for other contingencies as well, such as earthquakes, fires, power outages, or worse. That’s not what I do, but I just came across an excellent tool developed by Ready.gov to help businesses of all sizes develop plans for such contingencies. I thought it might be helpful for my readers and their clients who haven’t yet developed a contingency plan. Here is a link to the tool:

https://www.ready.gov/business-continuity-planning-suite

You will be prompted to download and extract a zip file which contains a suite of tools including some business continuity planning videos, a business continuity plan generator, and a business continuity plan training exercise to test your plan. I started the process myself and it seems pretty painless. I hope you find this tool makes it easy to write your own contingency plan and worry less about what will happen to your business in the event of a fire, earthquake, or other disaster.

And if you want to worry less about what will happen to your business and family if you get “hit by a bus”, click here to contact me about developing your own Hit by a Bus Plan.