Cross Purchase Buy-Sell Agreements

“We get along, and we plan to keep the business among the three of us.”

The Scenario

Megan O’Connor, Sandy Stewart, and Jennifer Rice became friends during their freshman year in college. They shared

a major, but they really bonded over baking crazy but delicious treats at 1 a.m. in their small dorm kitchen. After graduation, Megan and Jennifer took jobs with local

companies while Sandy went off to culinary school, then took a job at a restaurant in a nearby city.

The three got together one weekend, and in the process of catching up, realized that they all hated their jobs. While initially depressing, their talk soon turned to the idea of creating a business together. Soon after, the MSJ Baking Company was born, with the three of them as equal owners. Sandy moved back and her baking skills, combined with Megan and Jennifer’s business acumen, made their first small bakery a huge success. Over the next 30 years, the business grew to include six bakeries, two food trucks, and various cake mixes sold commercially throughout the state. It’s now worth roughly $9 million.

Over the years, Megan remained single and focused her energies on the business and on her sister’s three girls. Sandy married and had a child, but later went through a bitter divorce and is estranged from her only daughter. Jennifer married and had two boys who each became successful professionals. Despite their varied personal lives, the relationship among the three women remained strong, yet they never executed a formal buy-sell agreement. At

least, not until Jennifer got a positive result on a screening test for ovarian cancer (luckily, it was soon determined to

be a false positive).

At age 54, the owners of MSJ now realize that, although they are not yet close to retirement, they are long overdue to put a formal succession plan in place. They realize that life could surprise them, and none of them have any interest in leaving their share of the business to family members.

CHARACTERS AND CONCERNS

Megan O’Connor – A co-owner of

MSJ Baking Company, she runs

the day-to-day operations of the

company. She is a dedicated and

loving aunt to her three nieces

and would love to leave them an

inheritance someday.

Sandy Stewart – A co-owner of

MSJ Baking Company. She is

the head baker and recipe/menu

creator. She is divorced and

estranged from her daughter.

Jennifer Rice – A co-owner of

MSJ Baking Company, she serves

as CPA, head of finance, and

marketing. She is married with

two grown boys, and recently

suffered a scare when she

thought she had ovarian cancer.

A Planning Strategy

The owners meet with their attorney, Len Falbe, who suggests a cross-purchase buy-sell agreement. They would implement this by each purchasing a life insurance policy on the other two owners. Since there are only three of them, and they are the same age and in good health, this should be fairly simple and will result in a total of six policies.

Len explains that the cross-purchase buy-sell agreement will state that:

1. The deceased business owner’s estate must sell the business interest to the surviving owners. This prevents

outsiders from interfering with the business, since none of them want their heirs to be involved.

2. The remaining partners must purchase that interest. Megan, Sandy, and Jennifer can rest easy knowing that their wishes to keep their business between themselves will be fulfilled.

Since the surviving owners are required to buy the interest after one of them dies, they must have the funds available to make the purchase. This is where the life insurance policies come in. Each partner’s interest is

currently worth about $3 million. When one partner dies, the other two will receive death benefits of $1.5 million, or half the purchase price for the business interest. This

allows the other two to buy an equal share of the interest.

MORAL OF THE STORY

Often, business owners want their families to benefit from their business interest when

they pass away, but don’t think their heirs should actually be involved in the business. A buy-sell agreement protects both the

heirs and the remaining business owners. The heirs receive a fair price for the business interest, and the surviving owners can

rest assured that an outsider will not suddenly become a co-owner. By ensuring a smooth transition in ownership, a buy-sell

agreement fully funded with life insurance greatly increases the company’s ongoing chances of survival.