Entity Buy-Sell Agreements
The Scenario
Lou and Bobby DeWitt had always been interested in cars. Lou went to college and majored in business, and Bobby used his natural charm to become a successful salesman in a car dealership. When Lou finished school, they started their own dealership—DeWitt’s Luxury Drives. Decades
later, business was stronger than ever, and Lou’s four boys (Luke, Matt, Ned and Ollie) joined them at the dealership. When Lou died suddenly of a heart attack at the young
age of 60, his half of the business passed to his boys, making them co-owners with Bobby.
Now, at age 68, Bobby continues to work in the office, but the brothers do most of the heavy lifting in the business. However, it is Bobby who calls a meeting to discuss a
succession plan. While it worked fine for the boys to inherit Lou’s share of the business, Bobby’s children—an orthodontist, a physical therapist and a teacher—do not
have the desire or ability to work in the dealership. Bobby questions whether any of his nephews have liquid assets sufficient to purchase his half of the business. He doesn’t want his kids to be stuck with an asset they can’t sell—or worse, be forced to sell to an outsider. Bobby suggests a buy-sell agreement.
The boys agree. Ned notes that if one of them were to die first, their children and spouses are equally unable to work
in the business. Luke is familiar with cross-purchase buy-sell agreements, where each owner buys life insurance on every other owner. But they soon realize that it would be
costly for them to insure their uncle, who is quite a bit older than they are. Also, they would each have to purchase four policies, for a total of 20. To Luke, the plan sounds unwieldy and expensive. They decide to ask their attorney, Douglas Peele, if there are any other options.
CHARACTERS AND CONCERNS
Lou DeWitt – Deceased. One of the founders of Luxury Drives and father to four of the current owners.
Bobby DeWitt – An aging founder and uncle to his four co-owners. He is concerned about the viability of the business if his half passes to his uninvolved children, and simultaneously concerned about leaving a fair and sizable inheritance for his family.
Luke, Matt, Ned and Ollie DeWitt – Lou’s four sons, all of whom worked in the business and are now co-owners with their
uncle Bobby. Each is married with children.
A Planning Strategy
Douglas applauds the owners for tackling the issue of business succession, which he has urged them to do for quite some time. He also suggests that there is a simple
solution to their dilemma—an entity buy-sell agreement.
Under an entity buy-sell agreement, the business itself purchases a deceased owner’s share from the heirs. To fund these future purchases, the business would own life insurance policies on each owner (for a total of five, not the 20 required by a cross-purchase agreement), pay the premiums, and be the beneficiary. Each policy would
approximate the value of the owner’s business interest. Douglas suggests determining a formula that specifies
exactly how that value should be determined, possibly even requiring one or two appraisals.
When an owner dies, his share of the company will pass to his heirs. The business will receive the death benefit from the policy on the deceased owner. The business will need to go through the formality of
meeting the notice and consent requirements in order to receive the proceeds tax free. The business will then
use the proceeds to purchase the deceased owner’s interest from his heirs. In this way, the business will not struggle to buy back the share, and the heirs will receive a fair price without the stress of having to either work in the business or attempt to sell the
business interest on their own.
Douglas explains that buy-sell agreements in which the company owns the life insurance policies must be carefully structured to avoid undesirable tax
consequences, such as triggering the transfer-for-value rule or causing the inclusion of life insurance proceeds
in a taxable estate. After walking the owners through a couple options, including an irrevocable life insurance trust and an insurance LLC, Douglas suggests that they
also consult their own tax advisors before finalizing an entity buy-sell agreement funded with life insurance.
MORAL OF THE STORY
The beauty of the buy-sell agreement is its flexibility. There are many varieties, and each
business can tailor an agreement to fit their own unique situation. The trouble and expense of implementing the plan are very
small compared to the stress, hassle and cost to heirs if there is no succession plan in place. For business owners concerned
about the ongoing viability of the business and the inheritance of their heirs, a buy-sell agreement funded with life insurance is of
critical importance.
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