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Wait and See Buy-Sell Agreements July 17, 2000 (Principal Financial Group) Buy-sell agreements can provide estate liquidity and business continuity upon the death, disability or retirement of an owner. However, choosing the best structure for the agreement, cross purchase or stock redemption, is difficult because of conflicting considerations. This article discusses a third option, the "Wait and See" buy-sell, which offers greater flexibility.
Structuring the Buy-Sell
Business owners may delay implementing a buy-sell agreement because conflicting factors offer no clear choice. Cross purchase offers a basis step up for surviving owners, but an entity redemption may require fewer policies. Additionally, circumstances may change dramatically before the agreement comes into play.
A "wait and see" agreement may solve this dilemma. Under a wait and see, the decision as to whether the entity or the individuals will be the purchaser is deferred until a buy-out situation actually arises.
Waiting allows the decision to be based on the circumstances present at the time and allows flexibility to adopt the agreement to circumstances arising prior to a buy-out situation. Finally, it removes an obstacle to immediately establishing a buy-sell agreement.
Mechanically, the agreement gives the entity (for example, a corporation) the first option to purchase the decedent's stock. Then, surviving stockholders have an option to purchase stock not purchased by the corporation. Finally, the corporation must purchase any stock remaining after the stockholders exercise or waive their options.
Caveat
The stockholders should not be given the final obligation to purchase the stock. The corporation's exercise of its option in that situation could be construed as relieving a stockholder of an obligation and characterized as a constructive dividend.
Policy Ownership and Beneficiary Designations Either the entity or the individuals can own the policies. If, upon an owner's death, the entity owns the policy and it is decided that the corporation should be the purchaser, the corporation purchases decedent's stock with the insurance proceeds. However, if it is decided that the surviving stockholders should be the purchasers, the corporation can loan the proceeds to them.
On the other hand, the individuals could be the policy owners and beneficiaries. If, upon the death of a stockholder, it is decided the stockholders should be the purchasers, they purchase decedent's stock with the proceeds. If it is decided that the corporation should be the purchaser, the individuals loan the proceeds to the corporation.
A benefit of individual ownership is that the policies can later be transferred to the corporation without violating the transfer for value rule. If the arrangement begins with corporate ownership, a transition to a cross-purchase arrangement would violate the transfer for value rule. Summary
Wait and see buy sell agreements provide greater flexibility than either straight cross purchase or entity redemption plans and may remove obstacles that cause owners to delay implementing a buy-sell plan.
Please send your comments, questions and article proposals to information@smartpros.com.
2000, Principal Financial Group. All Rights Reserved.
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