RFC Business Planning & Owner Strategies 1 — Questions and Answers
Question 1: Under a cross-purchase buy-sell agreement, who purchases a departing owner's business interest?
- The business entity itself
- The surviving owners individually (Correct answer)
- A trustee designated by the agreement
- The departing owner's estate
Correct answer: The surviving owners individually
In a cross-purchase agreement, the surviving owners personally purchase the departing owner's interest, giving them a stepped-up cost basis.
Question 2: Which primary advantage does a cross-purchase buy-sell agreement provide to surviving owners compared to an entity purchase (stock redemption) agreement?
- Fewer life insurance policies are required
- Surviving owners receive a stepped-up cost basis in the purchased interest (Correct answer)
- The business entity pays all premiums
- Transfer taxes are completely eliminated
Correct answer: Surviving owners receive a stepped-up cost basis in the purchased interest
Because surviving owners personally purchase the interest, they receive a stepped-up basis equal to the purchase price, reducing future capital gains on a later sale.
Question 3: A 'wait-and-see' buy-sell agreement is best described as one in which:
- The business has no obligation to purchase a departing owner's interest
- The entity has first right to purchase, followed by the surviving owners if the entity declines (Correct answer)
- Surviving owners must decide whether to buy at the time of the triggering event
- The purchase price is determined after the triggering event occurs
Correct answer: The entity has first right to purchase, followed by the surviving owners if the entity declines
A wait-and-see agreement gives the entity the first option to redeem shares; only if the entity declines do the individual owners have the option to purchase.
Question 4: Which business valuation approach estimates value by dividing a company's normalized earnings by an appropriate capitalization rate?
- Asset-based approach
- Market comparable approach
- Income approach using capitalization of earnings (Correct answer)
- Liquidation value approach
Correct answer: Income approach using capitalization of earnings
The capitalization of earnings method, an income approach, divides stabilized earnings by a capitalization rate that reflects the business's risk and growth prospects.
Question 5: Which business entity form avoids double taxation while providing all owners with limited liability protection?
- C Corporation
- General Partnership
- S Corporation (Correct answer)
- Limited Partnership with a corporate general partner
Correct answer: S Corporation
An S Corporation is a pass-through entity, so income is taxed only at the shareholder level, while all shareholders enjoy limited liability.
Question 6: Which business valuation method determines value primarily by comparing the subject company to recent sale prices of similar businesses?
- Discounted cash flow method
- Market approach (Correct answer)
- Capitalization of excess earnings method
- Book value method
Correct answer: Market approach
The market approach derives value from actual transactions involving comparable companies, using metrics such as price-to-earnings or price-to-revenue multiples.
Question 7: When funding a buy-sell agreement with life insurance in a corporation with three equal owners, how many policies are required under a cross-purchase structure?
- 3 policies
- 6 policies (Correct answer)
- 9 policies
- 1 policy
Correct answer: 6 policies
With three owners in a cross-purchase plan, each owner insures the other two, requiring 3 × 2 = 6 individual policies.
RFC Business Planning & Owner Strategies 1
Under a cross-purchase buy-sell agreement, who purchases a departing owner's business interest?