General Practice, Solo & Small Firm DivisionMagazine
Volume 17, Number 1
BUY-SELL AGREEMENTS: INSURING YOUR FUTURE
BY SHARON A. MERKLE
Protecting a practice in case of death, disability, retirement, or withdrawal of an owner should be among the first concerns of any lawyer. Many solo practitioners and their dependents, unfortunately, consider this type of protection only after the need arises. A formal buy-sell agreement is an important part of your business.
While the process of designing, structuring, and funding a buy-sell agreement is too complicated to cover in this article, here are three key points to consider in developing a succession plan. First, establish the value of the practice. This may be a difficult process, because the value is closely linked to the entrepreneurial spirit of the firm's principals and must also be updated periodically for growth. Organizations such as The Institute of Business Appraisers, Inc., can provide expertise in this field, as can CPA firms who have a valuation division.
The next step is to determine who will purchase a departing owner's interest. If the practice is a corporation, partnership, or limited liability company, a plan can be developed to divide the interest among the other owners. In the case of a sole proprietorship, another solution will have to be found. Two basic ways to structure a buy-sell agreement are: (1) redemption or entity purchase, where the business itself purchases the interest; and (2) cross purchase, where the remaining owners purchase the interest.
Factors such as the number of owners, their tax brackets, and the funding vehicle chosen often determine which approach is utilized. Your legal and tax advisors can present the details of each scenario and determine which will benefit you the most.
The Funding Vehicle
The third important consideration in developing a buy-sell agreement is selecting the proper funding vehicle. Basically there are three choices: cash, borrowed funds, and life insurance benefits from policies covering the owners' lives. Each method offers both advantages and disadvantages. However, the overriding factor in selection is usually cost.
Paying cash for an owner's interest at a time when a firm has just lost the services of that owner may not be the wisest move, and smaller firms are often cash poor. If you have to consider installment payments, the departed owner (or heirs) is likely to charge interest, which will increase the cost of this method. The same applies to borrowing funds, even from a bank where you have a long-term relationship. The loss of an owner often impacts the creditworthiness of the business, making bank loans difficult to obtain, as well as expensive.
Life insurance may be chosen as the simplest and most cost-effective method for obtaining the cash needed to buy out a business interest. Premiums for permanent life insurance remain level, and the death benefit and cash value become available to fund the purchase when an owner dies, leaves the business, or is no longer active.
A buy-sell agreement helps protect the interest of all parties involved, ensuring that conflict between the former owner, heirs, and new or remaining owners doesn't endanger the success of the practice.
Sharon A. Merkle is a registered representative of AXA Advisors, formerly The Equitable Companies. Prior to joining AXA Advisors in 1999, she was a practicing attorney and a law firm partner, with a practice concentrated in business counseling and complex commercial litigation. AXA Advisors is the exclusive financial services provider for the ABA General Practice, Solo and Small Firm Division. For more information on buy-sell agreements, Merkle can be reached at 518/373-7344. For more information on what AXA Advisors can do for Section members, call 800/992-0790.