UT CENTER FOR FAMILY& PRIVATELY HELD BUSINESSES

1. UT CENTER FOR FAMILY& PRIVATELY HELD BUSINESSES Mini-Forum January 12, 2010 BUY/SELL AGREEMENTS IN YOUR BUSINESS Presented by: Gary M. Harden, Esq. Eastman & Smith Ltd. (419) 247-1677 gmharden@eastmansmith.com Presented by: Bruce D. Lazar, Esq. Eastman & Smith Ltd. (419) 247-1690 bdlazar@eastmansmith.com

2. Why do you need a Buy/Sell in your business? A Buy/Sell Agreement can achieve the following goals: • Provide that upon the occurrence of a specified “triggering event” owners are guaranteed that their interest in the business will be purchased • Provide that the owner’s interest must be sold to the company, the remaining owners, or a combination of the two • Provide a mechanism whereby the purchase price may be predetermined or determined by market conditions in existence at the time of purchase • Provide a funding source, primarily through insurance policies, so that the liquidity needs of the business or its owners will not be onerous • Establish a valuation of a deceased owner’s interest in the business for estate tax purposes

3. When does the buying and selling occur? Trigger Events – Events requiring a sale and purchase of an ownership interest: • Death of an owner • Disability of an owner • Retirement of an owner • Termination of employment • Bona fide offer from third party • Divorce • Bankruptcy • Attachment by creditors • Voluntary withdrawal • Breach of the terms of the agreement (or other agreements e.g, Non-Compete).

4. What are the different types of Buy/Sell Agreements? • Types of Arrangements • A. Entity Redemption – the business entity purchases/redeems the • ownership interest • Issues– Life insurance subject to entities creditors • – Tax consequences • – Attribution • – Tax basis • B. Cross-Purchase – the surviving/remaining owners purchase the • ownership interest. • C. Wait and see arrangement – a purchase option goes to the entity, • then to the owners. • – provides flexibility to plan at the time of a trigger event.

5. What are the Key Terms to aBuy/Sell Agreement? A. Transfer Restrictions • Prohibition on Transfer – absolute prohibition • Permitted Transfers: – Estate Planning – revocable trust • Prevent New Owners From Entering the Business

6. B. Trigger Events - Optional Purchase (right of first refusal) - Mandatory Purchase • Death – life insurance • Disability – definition • Retirement – age • Bona Fide Offer – match terms • Termination of Employment • Cause, no cause • fiduciary duty • Voluntary • Involuntary Transfer • Divorce • Bankruptcy • Breach of a covenant or agreement

7. C. Purchase Price for Interest • Agreed Value – owners agree on a value ahead of time. • If buyer & seller cannot agree, then: • Third party appraisal upon a trigger event – discounts, choice of appraiser, method  Valuation methods: – Book Method – net worth – Capitalization of Earnings – rate of return on investment – Discounted Cash Flow – present value of cash flow – Multiple of Earnings – EBITDA – Market Approach – Comparables • Draft a formula into the Buy/Sell Agreement

8. D. Payment Terms • Cash • Mix of Cash and Note (down payment) • Terms of Note – term – interest – security • Life Insurance Proceeds

9. E. Other Terms • Non-Compete • Non-Solicitation • Confidentiality

10. Funding • From Retained Earnings • C corporation: not deductible, so 2 layers of tax • S corporation: AAA already taxed, so tax free upon distribution • LLC/partnership: earnings already taxed, so tax free upon distribution • From other owners: Cross Purchase • From personal funds, with after tax dollars • Entity remains whole, not diminished • From insurance • Replaces value so the entity remains whole, not diminished • Proceeds upon death • Cash value • Bank/other loans • Installment sale

11. Repurchase Alternatives • Redemption • Retained Earnings: Sale/exchange or dividend? • Sale of a portion of the underlying assets • Dividend treatment in certain corporate settings • C corporation • S corporation • Insufficient surplus (personal liability shareholder & director to creditors) • Taxation of corporate owned insurance proceeds • C corporation • S corporation • Cross Purchase

12. Wait & See Approach • Series of offers starting with an offer (in whole or part) to the corporation • Use insurance and other tax free money • Use installment sale for unfunded portion • Then cross purchase • Use personally held insurance or insurance in a side partnership • Avoid insufficient surplus problem with appraised surplus or other personal funds, including installment sale