If you are a business owner in a family or multiple owner business, you may have heard of buy-sell agreements. You may be unsure of what they involve or if they are helpful. Here we will discuss what a buy-sell agreement is and why your company needs one.
What Is a Buy-Sell Agreement?
A buy-sell agreement is a legal document that allows for the re-allocation of business shares or partial ownership of a business in the event of an owner or partner’s death, disability, retirement, or other major life event. With a buy-sell agreement in place, new owners or existing business partners can purchase a stake in the company. As such, it obviously has enormous benefits for exit planning and should be created in the early stages of a planned transition if the company does not already have one.
This legal document details exactly how a business will divide up assets and ownership should something happen to the business, one of its owners, or should an owner want to exit. This is enormously helpful in many ways.
First, a buy-sell agreement takes all of the guesswork out of a transition. By ensuring there are no surprises should something unexpected happen, all the parties involved can relax. There is no point in manipulating or attempting negotiations when everything has already been negotiated and included in the agreement. It also ensures that important matters about the business will be decided by the owners and not courts or executors and that owners will not have to manage the company with people they do not like or respect – which can be a risk when spouses and children are involved.
A typical buy-sell agreement will also use fixed prices, formulas, or appraisals to establish a reasonable sale price. It will detail how and when the transferred ownership will occur. It’s very important that the method of valuation used be specifically stated and that periodic appraisals continue to be done so that the price remains fair and all owners know what their ownership interests are worth at any given time.
What Do Buy-Sell Agreements Include?
Buy-sell agreements typically will specify:
- What type of agreement it is
- What kinds of events will trigger a mandatory or optional buyout
- What definition of the valuation date is imposed by the agreement
- What the baseline purchase price is and what the terms of payment are
- How the agreement will be funded
- Which transfers of an owner’s interests are permitted
- Which transfers of an owner’s interests are not permitted
- Non-compete agreements between the parties involved
Without a buy-sell agreement in place or with an improperly structured buy-sell agreement, tax issues and other financial difficulties can occur. It should be structured so that unnecessary taxes can be avoided. The agreement should specify whether the transfer of ownership will require payment in full or whether this can be paid for over time. It should take care of any anticipated cash flow problems either of the company or the purchaser. In many cases owners will choose to take out life insurance or disability policies in order to provide funding at the time of the trigger event so the company and the owner are not put at financial risk and the transition can proceed smoothly.
Who Is Involved in Drafting Buy-Sell Agreements?
Obviously, these agreements are very complex and will require time and consulting with a number of experts to make sure it’s accurate, detailed, and understandable. Business owners should involve their exit planning team. This will include attorneys, accountants, tax professionals, and business valuators, but it may also include insurance agents and wealth managers in order to get broad input from experts who are capable of protecting the many interests of all of the owners individually and the business itself.
Who Needs Buy-Sell Agreements?
Any business that has more than one owner or anticipates having more than one owner needs a buy-sell agreement. Without a well drafted, up-to-date agreement in place, both the business and the relationships between owners are at risk. There are many potential problems that can result from trigger events like death, disability, and divorce. All of those events cause problems for the individuals involved and are stressful and exhausting. Buy-sell agreements make sure that stress and pressure do not take down the business as well.
If you have any questions about buy-sell agreements, please contact us at Prometis Partners. We would be happy to answer them and discuss with you what needs to happen to position your business for a smooth transition of ownership whenever that time comes.