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The disadvantages of using a buy-sell agreement?

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    On balance, the advantages of having a well drafted buy-sell agreement in place outweigh any disadvantages that might be encountered. That is not always the case, however. For this reason, it is important to have your attorney review your particular facts and circumstances to help discern what possible tax and non-tax factors might detract from the use of a buy-sell agreement.

    The following are just some of the factors to consider. First, perhaps the most pressing factor that detracts from the benefits of a buy-sell agreement is that it prevents a business owner from selling his interest, while he or she is alive, to others not mentioned in the agreement. One of the requirements for a buy-sell agreement to be respected, for estate tax purposes, is that the business entity itself or the surviving business owners have a “right of first refusal” during the decedent business owner’s lifetime. Essentially, this prevents the owner from selling it to another person other than the existing co-owners. This may or may not be a problem depending upon the situation. Either way, it this factor should be considered carefully.

    Second, the purchase price set by the buy-sell agreement could become unrealistic over time (and at the death of the business owner). The economy could take a dive, and business could decline; or the opposite could happen and the business could become wildly successful. Under either of these circumstances, if one of the business owners were to die, the purchase price will have already been set—which could be either unfair to the surviving owners or unfair to the decedent owner’s estate. Furthermore, even if the parties attempt to modify the agreement due to a clear valuation disparity between the actual fair market value and the price set by the agreement, the owners might at that point be unwilling to amend the agreement before the death of a partner (e.g. the purchasing partner would seek to enforce a valuation that is below the market value, while the seller would seek to do the opposite).

    Third, when all of the owners are truly indispensable, it might be better to simply liquidate the business, rather than have it survive on. In this case, a buy-sell agreement would be unnecessary. For example, one partner might be the “brains of an operation,” but the other is the public “face” of the business and manages the most valuable client relationships. If either one of them were to die, so might the business. The parties should consider whether liquidating the business would be most advantageous under those circumstances. In so doing, they should think very carefully of the tax consequences of liquidation, as it can be costly from a tax standpoint. For example, if the business were a corporation (and did not elect S corporation status for tax purposes), and the business sold its assets in liquidation, it could result in a corporate level gain. Further, any subsequent distributions to the surviving shareholder might be taxed again if his or her basis does not match or exceed the value of the distribution. Essentially, it could result in a “double tax.”

    Fourth, sometimes a business owner simply wants to give his interest to his spouse and other beneficiaries (e.g. his immediate family). In that case, a buy-sell agreement might not be necessary. However, there are many drawbacks with this seemingly “simple” solution. We discuss it its own sub-section, below.


    A buy-sell agreement is most common when there are other owners. It provides a means for the other owners to purchase the decedent owner’s interest so the business can focus (as it should) on making profit. However, in some cases a buy-sell agreement might be unnecessary. Consider the situation where the decedent owner simply wishes his estate to receive his interest in the business. For example, Husband might be intimately involved with the business and desires, upon his death, that Wife inherit his ownership interest in the business.

    The business owner might think a buy-sell agreement is unnecessary under such circumstances. However, there are several important drawbacks connected with the “simply-leave-it-to-my-family” approach.

    First, your spouse might die before you. Second, the business must still be valued, either at the first death (depending upon how the trust is structured), or at second spouse’s death. As discussed elsewhere on this site, a properly drafted buy-sell agreement helps to fix the estate tax valuation of the business interest at a business owner’s death. Certain requirements must be satisfied (also explained elsewhere on this site).

    Third, even if your spouse is to inherit your business, the business interest must still be valued so that trustee properly funds the bypass and martial trust portions of the trust. This is where the “optimal marital deduction” language is crucial. There are different ways to draft that language for sub-trust funding, and it is important from a tax perspective to get them right. Relatedly, knowing the value of the business interest to fund one or more of those sub-trusts is likewise important for tax and non-tax reasons, and a buy-sell agreement can help in this respect.

    Fourth, your surviving beneficiaries might need liquidity more than a business interest that is hard to sell (and value). In addition, family conflicts often arise when the asset in the estate is not liquid.

    Fifth, the surviving spouse (or other beneficiaries) might not know anything about the business. If the decedent was indispensable to the business—because of his or her specialized knowledge, relationships with others, or possessed a certain skill—then it might simply be better for the other business owners (or the business itself) to purchase the decedent’s interest. It is unfortunate that sometimes the estate and eager but unskilled beneficiaries end up bankrupting a business that otherwise could have continued to flourish in the hands of another. Therefore, the best thing more often than not is simply to sell—in which case a buy-sell agreement is indispensable.

    Sixth, you could change your mind down the line. If you are later uninsurable, a buy-sell agreement might be practically infeasible. Consequently, the estate might be forced to sell for a lower valuation, to the detriment of your ultimate beneficiaries.

    For these six reasons, even if you desire to give your immediate family or your spouse your business interest, it would be wise to consult with qualified legal counsel regarding whether your estate and business would benefit from a buy-sell agreement.


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