Bruce, Tom, and Michele understand that a buy-sell arrangement will solve most of their objectives, but they realize that a traditional entity redemption or cross-purchase buy-sell arrangement would not meet all of their goals since in those types of arrangements the purchaser is set when the agreement is signed. All three of them met with their financial professional who came up with a possible solution to their situation – a wait-and-see buy-sell arrangement.

The wait-and-see buy-sell arrangement is a mix between an entity redemption and cross-purchase buy-sell arrangement. The difference being that the buyer is not decided until there is a death, disability, retirement, etc., of one of the owners. This will give Bruce, Tom, and Michele flexibility as to who the purchaser will be when the triggering event occurs.

If Tom were to die first, in the typical wait-and-see buy-sell arrangement this would be the situation:

• The business would have a first option to buy Tom’s stock from his estate.
• Should the business fail to exercise this option or exercise it only with respect to a portion of Tom’s stock, then Bruce and Michele would have a second option to buy his stock (or the remainder of it).
• If Bruce and Michele should leave any of Tom’s stock unpurchased, then the business, as the third option, must purchase any remaining portion (or all) of his stock. This assures Tom’s family that all the stock will be purchased and assures the surviving shareholders that they will succeed in having full control of the business.

Using Life Insurance to Fund the Arrangement

One complicating factor for this strategy is funding. Bruce, Tom, and Michele understand that each of them will need to be insured so the buyer will have cash to initiate any buyout. Each of the individual owners and the business are potential life insurance buyers. They don’t know if the funding should be set up like an entity redemption arrangement, where the entity owns the policies or whether the funding should be set up like a cross-purchase arrangement where each shareholder owns a policy on the others.

The business has the greatest exposure since it has a binding obligation to purchase the interest if the two options are unexercised, or incompletely exercised. It is essential to establish the life insurance ownership in the proper manner at the outset. For this purpose, either the cross-purchase approach or the entity redemption approach may be used. However, more often the wait-and-see buy-sell is funded under the cross-purchase structure. This is because it is generally more tax efficient to move the insurance proceeds from the surviving shareholder(s) to the business (if the entity option was elected) than to move the proceeds from the business to the surviving shareholder(s) (if the surviving shareholder option was elected).