Business Succession Planning for LGBT Business Owners
Proper estate planning is particularly important for the LGBT community due to the fact that same-sex marriage is not legal in most states and even in those states, same-sex couples are not afforded the privileges and benefits of federal law. With that said, even those with estate plans often do not take into consideration ownership interests in companies. Business succession planning is crucial to ensure the successful transfer of your company or to properly provide for your life partner and yet few business owners have planned for the eventual transfer of their business interests.
A common planning strategy for those who have ownership interest in a business is for the owners to enter into a buy-sell agreement, often referred to as a “business will”. A buy-sell agreement is a legally binding contract that can be used with all entity types. It stipulates that upon a triggering event, such as the death, disability, retirement or withdrawal of a principal, his or her share of the business must be sold to the remaining partners or shareholders, or to the business itself. The remaining partners, shareholders, or the business agrees to purchase the portion of the business owned by the deceased, retired, disabled, or withdrawing principal.
If an LGBT business owner passes away without a buy-sell agreement or an estate plan which takes the business into consideration, the assets will go to the deceased’s next of kin instead of the surviving same-sex partner. This is problematic for many reasons. First, the business interest will likely pass to someone that has no knowledge, skill, or worse – no interest in the business. A more common problem is that family members who do not approve of the same-sex relationship may refuse to cooperate or support the surviving same-sex partner. This is particularly problematic if the same-sex couple had co-ownership of a business. Now, the surviving partner is forced to co-own a business with the closest blood relative of the deceased partner. These issues can be avoided through a buy-sell agreement as part of holistic estate plan.
The buy-sell agreement should specify certain key provisions and be drafted by an attorney in collaboration with a financial planner and/or accountant familiar with the business and its stakeholders. It is critical that the buy-sell agreement set out the intent of the parties in a manner that is legal in your state.
The following are key provisions of a buy-sell agreement:
Parties – Who will be selling and who will be buying?
Mandatory – The buy-sell agreement must state that it is mandatory for the seller to sell and for the buyer to buy the business interest.
What is to be purchased? – This differs with each business type. For instance, it could be partnership interests, membership interests, stock – or for a sole proprietor, the business’ assets.
Price – How much does the owner or the owner’s estate get for his or her business interest and how much does the buyer have to pay for this business interest?
Timing of the sale – For all parties involved, timing of the sale is crucial.
Law – Which state law(s) will apply?
Modifications to the agreement – A buy-sell agreement usually exists for a number of years and therefore a process to update coverage must be established.
Termination of the agreement – There are valid reasons to terminate a buy-sell agreement, thus an exit provision is essential.
Funding a buy-sell agreement is just as important, if not more, than drafting the agreement itself. Too often business owners start the process of drafting a buy-sell agreement but fail to plan for how to fund the business-interest purchase when a triggering event occurs. The following are three common ways to fund a buy-sell agreement:
Pay cash – Requires large sums of liquid assets that may not be readily available at the time of an unforeseen event. A remaining owner may have to liquidate valuable personal or business assets below market value in order to raise cash quickly.
Borrow the money – The loss of an owner or key person may impair the credit rating of the business and its ability to borrow. Moreover, the principal plus interest must be repaid which can put a tremendous strain on the business budget.
Purchase life insurance – For most businesses, this is the most favorable option because money is available from the policy cash values or death benefit for the purchase of the business interests.
Advantages of Buy-Sell Agreements to the owner and his or her heirs:
Helps avoid family disagreements regarding the value of a business, as well as the legal and emotional costs of a valuation dispute
Specified proceeds can provide the decedent’s estate with funds to help meet estate obligations that can reduce or eliminate the need to liquidate other estate assets
Helps establish the value of the business for federal estate tax purposes and may, therefore, avoid costly and aggravating IRS litigation
The heirs’ economic futures will no longer be tied to the fate of the business and they will free from worry about the financial success of the business
Advantages of Buy-Sell Agreement to the business and/or surviving principals:
Ensures a smooth and complete transition of management and consolidation of business control in the hands of the agreed-upon group
The business and/or the surviving principal(s) are assured of the cash necessary to purchase the decedent’s interest
Prevents potential impairment of the business’ credit line
A properly drawn buy-sell agreement can protect a corporation’s subchapter S status by avoiding inadvertent conversion to C corporation status
Protects the business against inactive, unqualified, and/or potentially dissident heirs in the management of the business.
Now that I discussed the advantages of buy-sell agreements, I’ll highlight the four common forms of buy-sell agreements:
In a Cross-Purchase buy-sell agreement, each business owner purchases life and/or disability insurance on the other business owners and each owner is the beneficiary of his or her respective policy(ies). Upon the disability, death or withdrawal of one owner, the remaining business owner(s) can use the policy proceeds or cash values to purchase their pro rata shares of the withdrawing owner’s interest in the business.
A Stock Redemption buy-sell agreement is generally used with any business entity that has multiple owners who want to use the assets of the business to the fund the agreement. The business is the purchaser, owner, premium-payor, and beneficiary of life insurance policies on each owner’s life. When an owner dies, the business receives the death benefit and uses the proceeds to purchase the business interest from the deceased owner’s estate. The estate is paid the agreed-upon price, and the surviving business owners own the entire business. This particular form has nuanced tax implications and regardless of which type of buy-sell agreement you choose for your entity, an accountant should be consulted in addition to an attorney.
A Wait-and-See buy-sell agreement is advantageous due to its flexibility. The wait-and-see agreement is a hybrid agreement containing language of both previously mentioned buy-sell agreements which allows either the surviving principal(s) or the business itself to purchase the withdrawing owner’s interest. The decision is not made until an owner actually withdraws from the business.
The Combination buy-sell agreement is a non-traditional arrangement is which a general partnership is used to structure and fund a business buy-sell. This special arrangement combines the benefits of both a cross-purchase and stock-redemption, while avoiding their negative aspects. With this arrangement, in addition to establishing a traditional buy-sell agreement for the business, the owners of the business establishes a separate general partnership, which owns and names itself beneficiary of life insurance policies insuring the lives of the owners.
The role of life insurance is extremely important and indispensible to a properly drafted and planned buy-sell agreement. Life insurance owned by the buyer on the life of the seller is an attractive option to business owners because it negates the question of how the buyers will pay for the deceased owner’s share in the business. The death benefit is available immediately upon the business owner’s death, making it possible for the surviving family members to receive full fair-market value of the business interest.
Polices used to fund a buy-sell may be permanent or term. In situations where cost is a concern, especially in start-up businesses, term may be appropriate. However, it many situations, permanent policies are preferable because if the buy-out occurs during the owner’s lifetime, the case value of a life policy can be used to help provide part o the purchase price.
You put maximum effort into establishing and running your business. But are you taking the rights steps to make sure your business survive your retirement, disability, or death of an owner or key employee? For the protection of yourself, your family /or your life partner, business succession planning reduces the risk of loss at the death, retirement or disability of a key person. Business succession planning is crucial in for LGBT entrepreneurs to ensure the successful transfer of a company or to properly provide for loved ones, yet few LGBT business owners have planned for the eventual transfer of their business interests.