This is a presentation created for the CyFair Houston Chamber of Commerce Business/Networking Development meeting on February 3, 2015.

1. How to sell your business when you
retire, die or become disabled.
do it for love

2. 65-75 % of small business owners do not have any type of succession
plan in place should they retire, become disabled or die.
7 out of 10 thought about it. 1
25 % have retirement succession plans
35 % have death succession plans
17 % have disability succession plans
1 Trends in the U.S. Small Business Market, LIMRA 2013
Business Succession Planning

3. Why have a Succession Plan? do it for love
Link to the story shown above https://www.youtube.com/watch?v=QIDwqvC4pVs

4. Every business
regardless of its revenue, assets
or number of owners − should have a
Business Succession Plan!
Who Needs a Buy-Sell Agreement?

5. Who Will Keep or Buy An Interest In A Closely Held Business?
• Partner or Co-Shareholder
• The Business Entity itself
• Key Employee
• Third Party (i.e., competitor, vendor, etc.)
• Family Member

6. What is a Buy Sell Agreement?
• Business Owner’s “Will”
• Sale Triggered by Death, Disability, Retirement and Other Events
• Purchase of Appropriate Interest by
– Business,
– Remaining Owners,
– Key Persons or
– Family Members

7. What happens to a business when a owner dies?
1. Federal Estate Taxes are due within 9 month
2. Cash flow is affected.
The Need for a Buy-Sell Agreement

8. Advantages to the estate if you die.
• Provides liquidity for taxes and expenses
• Prompt payment
• Sets fair and reasonable price
• Determines the value of a deceased shareholder’s
interest for Federal Estate Tax purposes
• As little conflict as possible
The Need for a Buy-Sell Agreement

9. The Need for a Buy-Sell Agreement
Advantages to the departing owner upon retirement,
disability, etc.
• Provides money to help meet ongoing expenses
• Converts business wealth to personal wealth to pay
for retirement
• Prompt payment
• Sets fair and reasonable price
• As little conflict as possible

10. Advantages to remaining owners
• As little conflict as possible
• Prompt exit of heirs and the heirs family
• Continuity of management
• Stability for employees, vendors and clients
• Establishes a fair and reasonable price
The Need for a Buy-Sell Agreement

11. You can learn from other business owners planning mistakes
H.L. Hunt
Value of estate: $8 billion
Amount contested: $4 billion
Feuding parties: great-grandchild
and nephew, among others

12. You can learn from other business owners planning mistakes
Carl Pohlad – previous owner of the Minnesota Twins
Sold Twins for $24 million for estate planning
IRS claims value is $293 million
Dispute still unresolved

13. Other Triggering Events
• Loss of Professional License
• Bankruptcy
• Felony conviction
• Divorce, etc.

14. Children in the Business
• What are plans for succession?
• What about those not active?
– Is there spouse shareholder that is not active in the business?
– Are there non-related shareholders that are not active?
• Family block
– Are there minor children?
– Is there a right of first refusal offer?

15. Children in the Business
• Buy-sell agreement – is this the best way to transfer?
• Are other transfer strategies more appropriate?
– Installment sale to intentionally defective grantor trust
– Grantor retained annuity trusts
– Family limited liability companies
– Family limited partnerships

16. Who will buy the business if there are no heirs or business partners?
• Vendors
• Competitors
• Key employees

17. Key Employees
• If not buyers:
– What happens to them under new management?
– Employment contracts?
• Ties key employees and helps retain business value
• Protects employees future
• Prevents defections
– What about protecting the buyers?
• Establishes a more stable business
• Protects value

18. Buy-Sells and Estate Planning
• Business planning is a part of estate planning
• Buy-sells play an important role for several reasons
– Legacy planning
– Fixing the estate value

19. Fixing the Estate Tax Value
(General Rules, part 1)
• Price must be fixed or determined according to a
formula which is fair and reasonable when agreement
is made
• No party to the agreement can transfer during lifetime
his/her interest in the company without first offering it
the other parties at price set in the agreement
…..(continued)

20. Fixing the Estate Tax Value
(General Rules) …continued
• Estate MUST offer to sell at death at contract price
– (mere OPTION to sell NOT sufficient)
• Agreement must be bona fide business agreement, and
not a device to
– pass decedent’s share on to the NATURAL OBJECTS OF HIS
OR HER BOUNTY for LESS THAN A FULL AND
ADEQUATE CONSIDERATION
…(continued further)

21. Fixing the Estate Tax Value
(General Rules) …continued
• Terms of the agreement must be
– Comparable to what persons dealing
“AT ARMS’ LENGTH” would do
• Family members are “the usual suspects”

22. Valuation
1. Separate specialized area of expertise
2. Who might know
•Business Owners
•“if you were buying … if you were selling”
• Accountant
•Brokers in that area of business
•Professional Appraiser:
especially gives credibility to the number

23. General Methods of Valuation
•Book Value
•Earnings Based Formula – Capitalization
•Dividend Paying Capacity
•Multiple Formula
•Appraisal
•Revenue Ruling 59-60

24. General Methods of Valuation
•Revenue Ruling 59-60
1. Nature of the business and its history
2. Economic outlook and the condition of the business
3. Earning capacity of the company
4. Dividend paying capacity
5. Goodwill and other intangible value
6. Previous sales and the size of the block to be valued
7. Comparable sales.

25. Business succession for disability
Chism vs. Commissioner 1963
• When an employee/owner is disabled he/she no longer is an
employee.
• Wages can only be paid to employees.
• Any money paid that is greater than $25 is a gift.
• Income paid after disability is a taxable distribution AND
taxable income to the employee/owner.
• A formal document or a qualified sick pay plan is necessary
to avoid double taxation.

26. Types of Buy Sell Agreements
• Entity Purchase / Stock Redemption
• Cross Purchase
• Wait-and-See Approach

27. Entity Purchase Agreement
•An agreement between the business and its owners
•An entity purchase agreement between a
corporation and its shareholders is commonly known
as a Stock Redemption
•If funded with life insurance, the business is the
owner and beneficiary
• “Employer” owned life insurance must
comply with “EOLI” rules

28. Stock Redemption
29
Owner B
$50k Basis
Insurer
Owner B,
Family or
Estate
3. Policy Proceeds
C Corp
($1 million)
2. Buy Insurance on A & B
Owner A
$50k Basis
1. Buy-Sell Agreement
Case Study – C Corp Redemption

29. Stock Redemption
Results At Death
• No income tax to B’s Estate
• A owns business outright
• A’s basis remains at $50,000

30. Entity Purchase
31
Owner B
$50k Basis
Insurer
Owner B,
Family or
Estate
3. Policy Proceeds
S Corp, LLC
or
Partnership
($1 million)
2. Buy Insurance on A & B
Owner A
$50k Basis
1. Buy-Sell Agreement
Case Study – S Corp Redemption or
Partnership/LLC Entity Purchase

31. Results At Death
• No income tax to B’s Estate
• A owns business outright
• A’s basis increases
– For S corporation, can increase to $550,000
– For partnerships and LLCs, amount of increase depends
Why?
Entity Purchase

32. • S Corporation Redemption
1. B’s estate receives promissory note for payment of buy-out price
2. Business elects to “terminate the tax year”
3. New tax year starts with remaining shareholders
4. Business receives life insurance proceeds
5. Insurance proceeds increase the remaining shareholders’ basis
• Partnership or LLC Entity Buy-Out
1. Complicated tax rules resulting in basis adjustment
2. Insurance proceeds increase the remaining owner’s basis
Entity PurchaseResults At Death

33. Cross Purchase
• An agreement between or among the owners of a
business
• The agreement obligates the surviving owners to
purchase from the departing owner or the deceased
owner’s estate, his or her business interest at an
agreed upon price

34. Cross Purchase
Insurer
Owner B,
Family or
Estate
1. Buy-Sell Agreement
3. Insurance Proceeds on B’s
Death or Disability
Owner A
($500k policy on
B)
Owner B
($500k policy on A)
Owner A
2. Buy Insurance
on Each Other
4. Pay Buy-Out Price
paid to owner A
5. Transfer Ownership Interest

35. Cross Purchase
Results at Death
• A receives $500,000 income tax free
• A pays $500,000 to B’s Estate
• No income tax to B’s Estate on the transaction
• A owns the business outright
• A’s total basis is $550,000

36. Wait-and-See Approach
• At the time the agreement is structured, it may be
difficult to determine which method is better
• The wait-and-see approach defers the choice until a
triggering event occurs

37. How the Wait-and-See Approach Works.
• Business has first option to purchase
deceased/departing owner’s interest
• If not exercised, remaining owners have the option to
purchase
• If remaining owners do not purchase, the business
must complete the purchase

38. Owner A
Insurer
Owner B,
Family or
Estate
3. Policy Proceeds on B’s Death
2. Buy Insurance on Each Other
Wait-and-See Approach
Owner B
Business
($1 million)
1. Buy-Sell Agreement
4. Loan or Capital
Contribution, if needed
5. Business has first option to buy business interest
6. Option to Buy if Business Declines

39. Wait-and-See Approach
Results at Death It depends on choice!
A similar approach can be used for other
circumstance such as retirement disability, etc.

40. Comparison of Business
Continuation Arrangements
Cross Purchase Entity Purchase
Basic Mechanics • Each owner buys policy on other
owners
• Surviving owners use insurance
proceeds to buy-out deceased or
disabled owner
• Business buys policy on each owner
• Business uses insurance proceeds to buy-out
deceased or disabled owner
Advantages • Addition to basis
• No AMT concerns
• Simple to administer – fewer policies
Disadvantages • More difficult to administer –
more policies (N x (N-1))
• Potential transfer-for-value
concerns
• Personal funds used to pay
premiums (unless bonused or
split dollared)
• No addition to basis for C corporation shareholders
(contrast to S corp and partnership)
• Possible AMT for C corporations
• Premiums not deductible
• Potential realignment of ownership control
• Constructive ownership: attribution rules

41. Options for Funding a Buy-Sell Agreement
1. Surplus
2. Sinking fund
3. Installment payments
4. Borrowing
5. Life and Disability Insurance

42. Surplus
1. Rely on Corporate Surplus and Asset Liquidity
2. Uncertainty of Corporation Having Surplus at Any
Given Time: i.e., No Guarantee of Funds for
Premature Death
3. Rely on Self Enforcement

43. Sinking Fund
1. Essentially, a Savings Account
2. Uncertainty of Individual’s Ability to Save
3. Rely on Self Enforcement
4. No Guarantee of Funds for Premature Death

44. Borrowing
LOANS
• Ability to Borrow Uncertain
• Cost of Borrowing Uncertain
• There is an Interest Expense

45. Installment
BUYER SIGNS NOTE
• Parties Agree to Pay The Purchase Price in
Installments
• Payments Spread Over a Number of Years
• Family Must Rely on Continued Financial Health of
Obligated Party
• Common As a “Fall Back” Plan

46. Life and Disability Insurance
INSURANCE FUNDING
1. Most Reliable
2. Ascertainable Costs
3. Cost Recovery
4. Generally, Least Expensive Option
5. Guarantee of Funds in the Event of Premature Death
6. Cash Value Grows Tax Deferred
– Supplements Lifetime Buy-out

47. Conclusion
1. Do you have an Existing Agreement?
2. Do you need a review and update?
3. Here is where to start
– Contract terms
– Price
– New parties
– Funding

48. Please complete the evaluation.
Please note if you would like CPE credit.
Thank you for coming.