Broker Check

Business Succession

Every dealer has a different plan when it comes to exiting the business. Whether your plan is to pass the business to a family member, or to sell the dealership to someone else, we are here to help you. There are many components to a successful business transition including business valuation and the emotions of your family and employees. In addition, making sure your agreement is in line with your dealer agreement is another important item to consider as well.

Here are a few ways that we can help with that:

Buy-Sell Agreements

This is a contract in which the owner agrees to sell and another party agrees to buy the business under particular circumstances at a specified price.

Business Valuation

This is the heart of the buy-sell agreement, affecting not only the sale price but potentially the surviving owners, the heirs, and of course the IRS.

Section 303 Stock Redemptions

In a fairly illiquid estate, this is a way for heirs to come up with cash to pay a deceased business owner’s taxes and other death-time expenses without being forced to sell the business.

Disability Buy-Out Agreements

This is a way to protect the business in the event the owner becomes disabled for a prolonged period of time, either as a separate agreement or as appropriate language within a buy-sell agreement.

What Is a Buy-Sell Agreement?

When a business owner dies, the disposition of the owner's business interest can become a two-edged sword, creating problems for both the heirs and the business itself. There are critical questions to be answered:

  • Who will purchase the business interest?
  • What is a fair price?
  • When will the sale occur?
  • Where will the funds for the purchase come from?
  • Will My manufacturer approve the sale of my dealership?

This "disposition dilemma" is easily resolved when the owners have established a buy-sell agreement specifying:

  • the circumstances under which a sale will occur (an owner’s death, disability or retirement),
  • An manufacturer approved plan of who will purchase the business (the business entity, the surviving owners, a key employee, a competitor, or a third party), and
  • the valuation method to be used at the time of the sale.

The Purpose of Buy-Sell Agreements

A buy-sell agreement is a legally binding contract in which one party (the owner) agrees to sell and the other party (an individual or business entity) agrees to buy an ownership interest in a business. The buy-sell agreement should be drafted in consultation with legal counsel and tax advisors.

A properly drafted buy-sell agreement can serve several purposes for the business:

  • Creating a market for the business
  • Minimizing the possibility that the business might fall into the hands of outsiders
  • Minimizing the possibility that the parties involved will not be able to agree on a proper value for the business, and putting everyone on equal footing while all the parties are alive
  • Ensuring that the buyer has the necessary funds available to make the purchase of the ownership shares (when the agreement is funded with life insurance)
  • Providing a deceased owner's estate with needed liquidity by converting an illiquid asset into cash
  • Providing for the orderly transfer of the ownership of the business
  • Establishing the value of the business for estate tax purposes.

Buy-sell agreements may not only be limited to situations where an owner has died. Depending on how the agreement is structured, the buy-sell may also have provisions that are triggered by an owner's:

  • retirement or desire to sell
  • divorce
  • disability
  • bankruptcy

Business Valuation

At a retail store, you will find a tag indicating the price of each item. At a flea market, the parties may haggle to arrive at an acceptable price. For a publicly traded stock, you can look up the price of recent sales on the trading exchange. Unfortunately, determining the value of a closely held business interest is not nearly so easy. And if the valuation is done incorrectly, there could be serious financial consequences.

Business valuation is the process of determining the worth of a business, and there are many reasons for being as accurate as possible. A business valuation can be helpful to a business when seeking credit or determining the reasonableness of employee compensation (a subject often of interest to the IRS).

A business valuation is also the heart of a buy-sell agreement for a closely held business. Buy-sell agreements provide that surviving owners will buy a deceased owner's business interest at an agreed-upon price, and the deceased owner's estate will sell at this price. Business valuation makes it possible to determine the value of the deceased owner's business interest, which in turn determines the amount surviving owners must pay to the deceased owner's estate.

Of course, the deceased owner's heirs and the surviving owners are not the only ones interested in the value of the business. The Internal Revenue Service has an interest in this financial matter, too. The value of the deceased owner's business interest is included in the estate and therefore affects the amount of estate tax which may be payable. Consequently, business valuation must not only be fair to the surviving owners and the deceased owner's heirs, it must also be acceptable to the IRS. If not, extensive and costly litigation could result, and settlement of the estate could be delayed for years.

What Is a Section 303 Stock Redemption?

When a shareholder in a family corporation dies, the shareholder’s estate faces a unique liquidity problem. Often, these shareholders want the business to stay in the family, but the sudden liquidity needs arising at death (death taxes, probate costs, funeral expenses, etc.) could require these estates to sell off part of the business to generate cash. A forced sale in this circumstance would create a set of new problems:

(1) the business would have outsiders coming in as new shareholders; and
(2) if the corporation redeemed part of its stock to get cash into the estate, the cash distribution could be treated as a dividend.

Congress, recognizing this unique difficulty, passed IRC §303 of the Internal Revenue Code. In brief, IRC §303 allows a shareholder's estate or heir to sell to the closely held corporation enough stock to pay federal and state death taxes, estate administration costs, and funeral expenses without treating the transaction as a dividend to the redeeming shareholder.

Planning for the Disability of a Business Owner

Many businesses prepare for the death of an owner with a buy-sell agreement funded with life insurance. However, too many businesses do not make any preparations for transferring ownership in the event of an owner's disability. What happens if a business owner is disabled for a prolonged period of time and is unable to carry out business duties and responsibilities? To prepare for this contingency before it becomes a problem, the owners should consider some very important questions:

  • What arrangements are needed to buy out the disabled owner's interest if that should become necessary?
  • How is disability defined for this purpose?
  • How long must the owner be disabled before the buy-out is triggered?
  • When the time arrives, will the buy-out be mandatory or optional and will the agreement be enforceable?
  • How will the disabled owner's interest be valued? By whom? And when—at the time of disability or at the time of the buy-out?
  • Will the purchase price be fair and reasonable?
  • Is the buy-out to be made in a lump sum or as an income stream?

Appropriate language in a buy-sell agreement (or use of a separate disability buy-out agreement) can resolve all these issues by (1) spelling out the obligations of the parties to buy and sell the business interest and (2) setting a valuation formula to determine a fair and reasonable purchase price.

Why a Disability Buy-Out Agreement Is Needed

Disability may be a double expense to a small business. In the absence of an agreement, the owner may still receive a share of the profits or a salary. In addition, if the owner was active in the management of the business, the business may have to hire a suitable replacement, thereby "paying twice." For most businesses, this would not be an attractive long-term prospect. In fact, without a disability buy-out agreement in place, an otherwise healthy and prosperous business could be headed down the road to financial disaster. Co-owners and/or business associates may find their freedom to make decisions limited by the differing priorities of the disabled owner or by their own desire to protect their investments. These active owners may also be placed in the position of seeing their disabled associate share in the profits just as if he or she were still an active contributor to the business.

Please reach out for more personalized information. 

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