A traditional buy-sell agreement may enable the estate of an owner of a closely held business to raise cash to fund testamentary bequests and pay estate taxes. The agreement may also be effective in valuing an estate for tax purposes. Typically these agreements are funded by life insurance. However, a traditional buy-sell agreement for a family-owned business may be impractical, especially where only the immediate family operates the business.
Of course, the business may simply be sold following the death of the parent. However, it is unlikely that the family will receive adequate consideration from the sale of a single-owner business.
Another alternative is for the business to be carried on by the spouse and children of the owner. If among two or three children only one wishes to remain active in the business, this creates estate planning issues, since the business may comprise most of the weath of the estate. In this case, leaving the business to the child interested in continuing the business may be unfair to the other children, not to mention the surviving spouse. Simply leaving the business to the surviving spouse, a tempting option, is fraught with its own potential perils, since the surviving spouse may have no conception of how to manage the business.
One method of “equalizing” an estate which is comprised primarily of a family business is to create additional estate assets by purchasing life insurance. In this manner, each child can be left assets of approximately equal value, and the surviving spouse can be adequately provided for. If structured properly, the proceeds of the life insurance would not be part of the owner’s gross estate.
Another solution would be for the parent and child to enter into a modified buy-sell agreement. The parent would be obligated to sell, and the child to purchase, the business at a price determined under the contract. The consideration for purchase could again be provided for by life insurance carried on the owner’s life. An installment note could also be used in lieu of, or in conjunction with, a life insurance policy. In this case, the child would be obligated to make cash payments to the estate from cash flow generated by the business.
If the business is to be continued, it is likely that some variation of a buy-sell agreement will be utilized. To avoid family discord, professional appraisals of the business should be obtained initially and at regular intervals. The IRS will also be more likely to accept a value specified in the contract if buttressed by a professional appraisal.