What are Different Types of Buy-Sell Agreements

A buy-sell agreement is a legal contract providing terms for the disposition of business ownership interests if a specified ‘triggering event’ occurs. The most common triggering events detailed in buy-sell agreements are an owner’s death, disability, retirement or premature withdrawal from the business.

There can be many variations...
General business continuation agreements tend to take on four forms:
An Entity Plan agreement is between the business entity and individual owners. Owners may be partners; in which case the entity plan is referred to as a partnership liquidation agreement. For corporations, the succession plans are generally known as stock redemption agreements.
A cross-purchase agreement is between individual owners and may also be referred to as a “crisscross” agreement.

One-way buy-out agreements are between individual owners and key persons, family members or an outside person. A one-way agreement may also be referred to as a “third-party” agreement.

The hybrid plan is a combination of former agreements. When dealing with buy-sell agreements, they can be tailored to specific business succession planning needs. Hybrid plans can be a combination of various aspects of the agreements already mentioned.
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4 Main Ways to Fund a Buy-Sell Agreement
The doctor breaks his wrist and his leg which will require surgery using pins and screws to hold his bone in place. Healing may take months or longer and a surgeon that cannot stand nor use his left hand. This disables the surgeon from doing his job. Insuring such a risk (example above) with Key Person coverage, provides cash flow to help companies move forward and maintain a profit if a key employee becomes disabled. In this situation, high limit disability insurance is invaluable.
The 4 types of buy sell agreements above are useless if there is a triggering event such as death, disability or retirement of an owner if there is no funding source to establish a ‘ready market’ for transferring business interests from the owner’s estate to whomever agreement specifies. The most common ways to fund a buy-sell agreement are:
  • Sinking Funds: In this method of funding buy-sell arrangements, business profits are held back and used to cover the cost of a buy-sell arrangement. However, should an owner become deceased following the implementation of this strategy, then the business cannot accrue the necessary funding to fulfill its redemption obligation.
  • Installment Purchase: Buy-sell arrangements can also be funded by installment purchases. Bear in mind that this strategy has a major flaw due to its tendency to inhibit cash flow, which could cause dramatic effects if the interest purchased belongs to a majority owner. No cash flow could mean no business.
Types of Buy-Sell Agreements
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BORROW FUNDS
Borrowing funds is always an option when someone owes money, however, as most know, borrowing money comes with its downsides. Obtaining a loan may not be easy for the remaining partners or owners as the business will no longer have a key member of their business. Another cause for concern is if the business can acquire a loan for the buy-sell arrangement, future loans, whether for growth or as cash-flow, may prove to be difficult.
INSURANCE
Insurance is the most common and more efficient methods for funding a buy-sell agreement. Disability insurance or life insurance with LTC riders can serve as great funding vehicles for key person insurance, where triggering events may be a key person becoming disabled. Using term insurance for basic cross-purchase buy-sell agreements can provide a relatively inexpensive way for partnerships looking only to cover the death risk of other partners, but don’t have the resources for more expensive permanent insurance. On that note, most term insurance policies are convertible, which locks in insurability and allows conversion to permanent insurance (i.e. universal or whole life insurance). Furthermore, a buy-sell agreement funded with a permanent life policy that accumulates cash values, if planned for accordingly, can cover a buyout of a retiring owner. For uninsurable owners, fixed indexed or fixed annuities may be a viable option – with insurance and the customizability of various insurance product types, business succession planning can truly be tailored to each unique need!
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Types of Buy-Sell Agreements
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