Real Estate Weekly
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Debt & Equity

Op-Ed: Buy-sell agreements need regular upkeep

By Marc Newman, associate managing partner,
Anchin, Block & Anchin LLP

Construction company owners are more than familiar with the concept of maintenance. Equipment needs regular upkeep, homes and buildings require contant upkeep.

But you know what else needs regular maintenance? Buy-sell agreements, assuming you have one. Most any company with more than one owner should establish one of these legal agreements and, once it’s in place, ownership should review it periodically to ensure it still suits their needs.

Double-checking its purpose

The primary purpose of a buy-sell agreement is to legally confer on owners of a business or the business itself the right or obligation to buy a departing owner’s interest. But a well-crafted agreement can also help ensure that control of your construction business is restricted to specified individuals, such as current owners, select family members or upper-level managers.

Another purpose is to establish a price for the ownership interests. You should engage a valuation expert to estimate the value of those interests when first creating a buy-sell agreement, and periodically set a mechanism to ensure the price keeps up with the changing value of your company.

Estate planning is also a priority for many buy-sell agreements. If yours was drafted more than a few years ago, you may need to update it based on recent gift and estate tax changes under the Tax Cuts and Jobs Act of 2017. Specifically, the gift and estate tax exemption and the generation-skipping transfer tax exemption amounts have increased to an inflation-adjusted $11 million, or $22 million for married couples for the estates of persons dying, and gifts made, after December 31, 2017, and before January 1, 2026.

Watching out for triggers

Most buy-sell agreements lie dormant for years. What can quickly bring one to life is a “triggering event,” such as when an owner dies, becomes disabled, retires or voluntarily leaves the company for some other reason.

But you may want to make sure your agreement also covers events such as changes in an owner’s marital status. And to prevent fraud or inappropriate behavior, many agreements include “conviction for committing a crime, losing a professional license or certification, or becoming involved in a scandal” as a triggering event.

Inspecting the structure

Buy-sell agreements may be structured in one of three ways. First, a redemption permits or requires the business to repurchase an owner’s interest. Second, there’s a cross-purchase method, which allows or requires a group of the remaining owners of the company to buy the interest.

Third, the agreement may be set up using a hybrid approach combining the two preceding structures. A hybrid agreement might require a departing owner to first make a sale offer to the company and, if it declines, sell to a group of the remaining individual owners.

Be sure to consider the impact of the buyout structure on your balance sheet. A redemption may reduce your equity substantially while a cross purchase may not.

In choosing your buy-sell agreement’s initial language, consider the tax implications. They’ll differ based on whether your company is a C corporation or a flow-through entity (such as a partnership, limited liability company or S corporation).

Setting aside money

Buy-sell agreements require a funding source so that the company can buy the former co-owner’s shares. Life insurance is probably the most common, but there are alternatives.

If your company is cash-rich and confident in its ability to remain so, you could rely on your reserves. But this generally isn’t a good idea for construction businesses, which tend to have distinct ebbs and flows in cash flow as projects come and go and required equity levels for bonding and borrowing.

Another option is to create a “sinking fund” by setting aside money for buying out an owner over time. Again, this will affect your ongoing cash flow, but it might be a more measured way to gather funds until they become necessary.

Taking it in for a tune-up

A properly conceived and structured buy-sell agreement should perform like a well-built engine. But it may need a tune-up from time to time. Your CPA and attorney can help with the tinkering.

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