A Most Important Document

July 1, 2010 06:16 AM

It is one of the most important documents in the succession planning arsenal. It protects the operation from the whims of inactive owners and off-farm interests. It gives peace of mind to business partners and family members.

The document is called a buy-sell agreement, and it’s critical to succession success, says Kevin Spafford, Farm Journal succession planning expert. "A wellwritten and properly executed agreement ensures the operation remains in the family and is protected from death, disability, divorce and dissolution," he says.

The buy-sell agreement obligates one business owner to buy all or a portion of the business upon the retirement, death or disability of another business owner. In essence, it’s a blueprint for when a partnership breaks apart. The contract specifies who will buy the ownership interest, what price will be paid and how the interest will be bought. Terms of sale and when a sale will occur are often typically included.

TWO STRUCTURES. Most business owners look into one of two plans: 1) the cross-purchase plan; or 2) the entity purchase or stock redemption plan.

The cross-purchase plan requires each business owner to purchase a life insurance policy on each of the other owners. When an owner dies, the surviving owners use the death benefit to purchase the deceased owner’s share of the business.

An entity purchase (or stock redemption) plan between owner-employees requires each owner to enter into an agreement with the business for the sale of their respective interests to the business.

Which plan a farm business decides to go with depends on the situation and personal comfort level among the owners, says Mel Kitts, CPA with Kennedy and Coe LLC.

"In agriculture, there’s a real tax advantage to being organized as an LLC [limited liability company] over a corporation when a buy-sell takes place," Kitts says.

The advantages potentially are a step up in basis of the operating assets to take tax deductions for part of the buyout purchase price, he says.

CHOOSING LIFE INSURANCE. As part of the buy-sell agreement, the business purchases separate life insurance contracts on the lives of the owners. The business therefore pays the premiums and is considered the owner and beneficiary.

When an owner-employee dies, his or her share of the company passes to the heirs of his or her estate. The business may use the proceeds from the policy to purchase the interest from the estate.

"As a general rule, if the buy-sell is supposed to be funded for the life of the individual, the universal life type of policy is often used, given its flexibility for design," says Don Schreiber, director of advanced markets for Nationwide Mutual Insurance Company.

"The first goal with the insurance policy is to provide cash by using pennies to create future dollars," Schreiber says. "Second, the insurance policy needs to create a pool of cash that is going to be free of income and capital gains tax at the time when the business needs it.

"I always tell my clients that while a buy-sell agreement is very important, tax-efficient money to fund it is critical," Schreiber adds.

You can e-mail Jeanne Bernick at jbernick@farmjournal.com. 

Buy-Sell Review Tool

With so many components involved in a buysell agreement, it makes sense to periodically review your contract. The Farm Journal Legacy Project provides a free online buy-sell review tool to help assess the viability of your current agreement and identify those areas that should be updated. It can also be used to ensure that any new agreement you draft includes (or at least considers) the relevant points, provisions, and mechanisms.

Visit www.farmjournallegacyproject.com and click on Buy/Sell Review under the tab for estate planning legacy tools. 

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