The Key Benefits of Creating and Entering Into a Buy-Sell Agreement

The development of a new business venture typically is an exciting time for the owners involved in launching a new enterprise. By definition, the owners of a venture about to launch are optimistic about a business' future. Indeed, if the principals were not optimistic, they would not be preparing to start a new business in the first place.

The understandable optimism associated with a new venture must be tempered by reality. One such reality is the possibility that the day may come at which an owner of a business wants to sever ties with an enterprise. Due to the nature of closely held businesses, this can prove to be a messy and even a catastrophic proposition in the absence of what is known as a buy-sell agreement. There are some key benefits to the owners of a business entering into a comprehensive buy-sell agreement in the leadup to the launch of a new venture.

Definition of a Buy-Sell Agreement

Also known as a buyout agreement, a buy-sell agreement governs the manner of separation in a situation a co-owner of a business desires to, must, or has departed from a business. There are three primary situations in which the co-owner of a business separates from an enterprise:

Basic Provisions of a Standard Buy-Sell Agreement

A standard buy-sell agreement typically has three basic provisions:

Preserve a Surviving Owner's Right to do Business with Desired Co-owner

A key benefit of an appropriately crafted buy-sell agreement is that this type of contract protects a business owner's right to be in business with a desired co-owner or owners. With a buy-sell agreement, a remaining business owner has control over whom he or she shares ownership of an enterprise.

Establishment of Fair Price for Interest in a Business

Another of the important benefits of a buy-sell agreement is that it establishes what the parties agree is a fair price for a co-owner's interest in a business. This can be established in a number of different ways, including an agreed formula for computing the value of an ownership interest in a business.

The stark reality is that the time a co-owner separates from a business can be fraught with high-running emotions. Determining what truly is a fair price for an ownership interest can prove to be highly challenging in that type of environment when no buy-sell agreement exists.

Ending a Departing Owner's Decision-Making Authority

With significant frequency, a co-owner of a closely held business may reach a point in time at which he or she no longer desires to be involved in operation of an enterprise. Absent a properly drafted buy-sell agreement, a co-owner who reaches such a juncture will still retain management authority. Such a scenario can create truly undesirable situation.

Estate Planning Instrument

As noted previously, one of the reasons why a co-owner departs a closely held business is death. A comprehensive buy-sell agreement can prove to be an important estate planning device. By crafting and entering into a buy-sell agreement, the co-owners have the opportunity to obtain thoughtful legal advice from a capable attorney to ensure that that a deceased individual's ownership interest is properly addressed with estate, probate, and tax laws in mind.

Three Basic Types of Buy-Sell Agreements

In conclusion, there are three types of buy-sell agreements that most often are utilized by co-owners of closely held enterprises:

redemption agreement through which the business itself buys the departing co-owner's interest
cross purchase agreement where the remaining owners purchase the departing or departed co-owner's interest
hybrid agreement in which surviving owners have the first option to purchase a departing or departed co-owner's interest, the business itself being required to purchase the agreement if a remaining owner does not

Due to the complexities associated with ownership interests of closely held businesses, obtaining experienced legal assistance in drafting a buy-sell agreement is always advisable. Professional legal assistance ensures that the rights and interests of all owners of a closely held business fully are protected via a suitable, enforceable buy-sell agreement.

Why Your Business Needs a Buy-Sell Agreement

Why are buy sell agreements important? How do buy sell agreements work? What does a buy-sell agreement do?

If you own all or part of a business—any business—you should know about buy-sell agreements. Unless you plan to be lucky forever, you’d better have one. Without it, a closely held or family business can face a world of financial and tax problems on an owner’s death, incapacitation, divorce, bankruptcy, sale or retirement.

Qualified Sick Pay Plan: An Overview and Call to Action for Businesses

Consider this:  A key employee or your business partner has just had a heart attack.  His doctor says that he will be out of work for six months.  In the meantime, his family is counting on his salary to pay the bills.

What are you going to do?  Are you going to make payments to him while he is out of work?  Can you continue to take a tax deduction for those payments?  Can your company afford to make those payments while that key employee is out of work and, therefore, not generating revenue for your company?  Tough questions….  Keep reading to learn about what a Qualified Sick Pay Plan (QSPP) can do for your company.

First, here is a sobering statistic: Between ages 35 and 65, seven out of ten people will become disabled for three months or longer.  (Senate Finance Committee, 1998)  In fact, the risk of disability is greater than the risk of death between ages 20 and 65.  Freak accidents are NOT usually the cause; back injuries, cancer, heart disease and other illnesses cause the most long-term absences from work.  No company (yours included) is immune from having a key employee go out on disability, and you should really consider planning for that.

Next, let’s talk taxes.  When an employer pays an employee “wages,” the employer can deduct from its taxable income those wages paid (along with the FICA contributions on them).  This is a good thing.  Many firms do not realize, however, that the IRS often disallows this deduction when an employer pays a disabled employee.  This includes payments to the owner, family members, and key employees.  Having a Qualified Sick Pay Plan in place before an employee goes out on disability should preserve your company’s tax deduction for payments made.

So, establishing a Qualified Sick Pay Plan can solve your tax problem, but a company should also address the funding and administration of the plan.  Should the company “self-insure” and retain the risk of having to pay disability benefits out of company assets, or should the company obtain an insurance policy to transfer that risk?  Like most things, each method has its pros and cons.  For example, if you obtain insurance, you have to pay premiums even when no one is out on disability, BUT the insurance company (not you) assumes the risk for claims.  On the other hand, if you self-insure, you decide eligibility for and the amount of benefits paid to the disabled employee, but your company is now a “man down” and, presumably, making less money than when the employee was contributing to the bottom-line.

Simply put, if you are a business owner, you should consider putting a Qualified Sick Pay Plan in place right away.  The plan itself is a relatively simple legal document, and the legal fees for doing so are quite small in comparison to the financial consequences of having no plan at all.  Your lawyer can also advise you on whether to self-insure or obtain an insurance policy to transfer the risk.

Do not put this off.  At least discuss putting in place a Qualified Sick Pay Plan with your lawyer, financial planner, or insurance agent today, and get this simple document in place right away.  The odds are that you will be happy you did.

Consider this:  A key employee or your business partner has just had a heart attack.  His doctor says that he will be out of work for six months.  In the meantime, his family is counting on his salary to pay the bills.

What are you going to do?  Are you going to make payments to him while he is out of work?  Can you continue to take a tax deduction for those payments?  Can your company afford to make those payments while that key employee is out of work and, therefore, not generating revenue for your company?  Tough questions….  Keep reading to learn about what a Qualified Sick Pay Plan (QSPP) can do for your company.

First, here is a sobering statistic: Between ages 35 and 65, seven out of ten people will become disabled for three months or longer.  (Senate Finance Committee, 1998)  In fact, the risk of disability is greater than the risk of death between ages 20 and 65.  Freak accidents are NOT usually the cause; back injuries, cancer, heart disease and other illnesses cause the most long-term absences from work.  No company (yours included) is immune from having a key employee go out on disability, and you should really consider planning for that.

Next, let’s talk taxes.  When an employer pays an employee “wages,” the employer can deduct from its taxable income those wages paid (along with the FICA contributions on them).  This is a good thing.  Many firms do not realize, however, that the IRS often disallows this deduction when an employer pays a disabled employee.  This includes payments to the owner, family members, and key employees.  Having a Qualified Sick Pay Plan in place before an employee goes out on disability should preserve your company’s tax deduction for payments made.

So, establishing a Qualified Sick Pay Plan can solve your tax problem, but a company should also address the funding and administration of the plan.  Should the company “self-insure” and retain the risk of having to pay disability benefits out of company assets, or should the company obtain an insurance policy to transfer that risk?  Like most things, each method has its pros and cons.  For example, if you obtain insurance, you have to pay premiums even when no one is out on disability, BUT the insurance company (not you) assumes the risk for claims.  On the other hand, if you self-insure, you decide eligibility for and the amount of benefits paid to the disabled employee, but your company is now a “man down” and, presumably, making less money than when the employee was contributing to the bottom-line.

Simply put, if you are a business owner, you should consider putting a Qualified Sick Pay Plan in place right away.  The plan itself is a relatively simple legal document, and the legal fees for doing so are quite small in comparison to the financial consequences of having no plan at all.  Your lawyer can also advise you on whether to self-insure or obtain an insurance policy to transfer the risk.

Do not put this off.  At least discuss putting in place a Qualified Sick Pay Plan with your lawyer, financial planner, or insurance agent today, and get this simple document in place right away.  The odds are that you will be happy you did.

The Limited Liability Company (LLC) in Virginia, an Overview

Entrepreneurs often cite the tax benefits and/or the limited liability as reasons why they chose to create a limited liability company (LLC) for their business.  Others will merely say that they followed the advice of a sister, who is a CPA, or an uncle, who is a lawyer.  Still, some will blindly do whatever the Internet tells them.

Yes, the tax benefits of an LLC make sense: the business’ revenue is taxed at the owner (or “member”) level.  This is often called “pass through taxation.”  On the other hand, corporations face “double taxation” which means that its owners pay taxes at both the business level (for revenue earned by the business) and the member level (for income earned by an owner).  By establishing an LLC, an owner pays taxes on his or her receivables from the business, just like any other employee.  Similarly, sole proprietors are taxed in this manner. Of course, tax specialists are a great resource for determining the most appropriate and beneficial taxable entity for the LLC.

So why bother going through the exercise of setting up an LLC if you’re just going to be taxed as if you were a sole proprietor?  The answer is simple: limited personal liability. Creditors can only access the business’ assets, such as inventory, computers and bank accounts, in the event the business cannot afford to pay them.  As a result, your personal assets (property, bank accounts, etc.) are protected from creditors.  While most, if not all, business owners don’t expect to run into this problem, savvy ones are prepared for the worst while working hard for success.

Sounds easy and logical, right?  Well, there are some pitfalls that can result in personal liability if the business owner is not careful.  These triggers will be discussed later in this blog entry.

LLC owners enjoy benefits beyond those related to taxes and liability.  By establishing an LLC, you have given your business a greater opportunity to raise capital.  One option for financing the business is through selling ownership.  Of course, a business owner will likely want to retain some percentage over 50%, usually 51% to maximize the amount of capital that can be collected.  Non-LLC entities (for example, C-corporations) must share records, notify shareholders of meetings, and observe other formalities.  If an LLC’s articles of incorporation are written properly, many of those formalities can be legally avoided, thereby saving the owner valuable resources, especially time.

All business owners want to be perceived as legitimate, professional and trustworthy by potential customers and clients, especially those within their target market.  Having the initials “LLC” next to a business name can provide that instant credibility because it demonstrates that the entity’s existence is on record with the State Corporation Commission.  An inference can be made by potential clients that the business has its affairs in order and is worthy of being taken seriously since it has taken the proper steps.

In addition, the life of the LLC is set forth in the articles of organization.  Often times, this attribute achieves a business owner’s desire for the business to continue with the same name, assets and goodwill.  For sole proprietorships, the business simply folds when the owner retires or is no longer able to manage the business.

Putting all those benefits aside, let’s get back to the topics of limited personal liability and the pitfalls that can jeopardize this protection.  In many ways, business owners feel indistinguishable from their business, which is understandable due to the sacrifices they’ve made and the “sweat equity” (or the time and energy) they’ve invested into the business.  Nevertheless, business owners need to draw a clearly defined line between themselves as individuals and the business.  If a court finds that a business owner failed to “observe corporate formalities,” creditors can obtain a judgment in which they can stake a claim on that business owner’s personal assets, including real estate, automobiles, and bank accounts.

One of these corporate formalities is to establish and maintain separate bank accounts.  Mixing personal and company funds, commonly known as “commingling,” is the easiest way for creditors to reach a business owner’s personal assets.  Members are also expected to keep the business sufficiently funded, which includes acquiring sufficient insurance.  When marketing the business’ services and/or products, the owner should act as an employee of the company.  Using official letterhead for all business-related communication can assist with establishing a clear line between one’s personal activities and business dealings.

Another formality is entering into agreements as an agent of the LLC.  Although it is difficult (if not impossible) to get a loan for a new LLC without making a personal guarantee, members should sign most other contracts as an agent on behalf of the LLC.  In short, if lines are blurry between one’s business and personal activities, the business owner might become personally liable for claims and debts against the business.

If you are thinking of starting a business, we can help.  If you already have a business but are concerned that it might not fully protect your personal assets, we can assist with mitigating your risk.  Email us at info@golightlylaw.com to inquire about our services.