“Buy-sells between family members are considered an area of possible abuse, so such agreements are scrutinized closely,” Fulbright says. The IRS feels such agreements tend to be low-balled to save gift and estate tax. Therefore, you will need a formal valuation, drafted by an unrelated and reputable appraiser, in order for an intrafamily buy-sell to pass IRS review.
The funding. These days, a successful small business might be valued at several million dollars. A buyer probably will be hard-pressed to come up so much cash, even if he or she has an obligation under the buy-sell. “An appropriate life insurance policy can fund a buyout agreement,” says Lee Slavutin a principal at Stern Slavutin 2 Inc., a life insurance and estate planning firm in New York City. You might own a policy on the life of your business has a policy on Ann’s life. When one of you dies, the other will collect the insurance proceeds, which can be used to pay the agreed-upon price. Also, “Disability buy-out insurance may be used to fund a buy-sell that’s triggered because an owner no longer can work,” Slavutin says. For retirement, a cash value life insurance policy might be tapped; alternatively, a retirement buyout may be funded from accumulated earnings or paid in installments from the company’s ongoing profits.
The buyer. For buy-sells among co-owners, two approaches are possible. One is the “cross-purchase” agreement. One partner buys the business interest from the other, depending on who is the first co-owner to depart. The other option is a “redemption” agreement. So, when one shareholder dies, the company buys his or her shares. The other shareholder will then become the sole shareholder. Buy-sell agreements often give the remaining co-owner a right of first refusal. If this right is waived, the company will buy the shares that are up for sale. With this approach, the surviving co-owners can consider all the circumstances (such as cash needed and tax concerns), then choose between a cross-purchase and a redemption buyout.