You Need a Buy-Sell Agreement for Your Business
Every business should have a buy-sell agreement to protect the owners, their families, employees and the company. Without a buy-sell agreement or succession plan, any company is at risk, notes a recent article titled “Why does your business need a buy-sell agreement?” from the Philadelphia Business Journal.
If a business owner has a partner, and that business owner dies or becomes unable to act due to incapacity, then the question becomes how does that owner’s spouse or heirs get their rightful share of the business? They can be placed in a position of being held hostage by the surviving partner. This can create a very increased risk of litigation and animosity amongst your heirs and your partner. It’s better to have a Buy-Sell Agreement clearly setting forth the terms of the succession to the business.
Many business owners are reluctant to recognize the possibility of their becoming disabled or dying, so they put off creating a buy sell agreement. However, as we all know, unexpected events happen and it’s always better to be prepared.
A buy-sell agreement offers protection first by establishing what type of triggering events could happen and defining the terms and conditions for how shareholders will enter and exit their ownership of the business.
Companies often have a buy-sell agreement for a business stuck in a file drawer from ten or twenty years ago. Chances are that big changes have taken place in the business and the old agreement is no longer relevant. The day-to-day operations of a business are pressing, and there’s never enough time to get around to it. However, when the unexpected occurs, shareholders are left to negotiate among themselves during the worst possible time.
A well-drafted buy-sell agreement should address the most common events: death, disability, divorce, personal bankruptcy, voluntary termination, retirement and involuntary separation. The agreement should clearly state the percentage and type of ownership, how shares are valued and how any insurance proceeds are to be handled. Without knowledge of the value and terms of payment, there’s no way to provide protection for a triggering event.
Once the value of the company and its shareholders is defined, it may become clear that a business needs to close a valuation gap.
The intentions for the future of the business can also be clarified through this process. Some provisions to consider in buy-sell agreements for businesses are:
- How to notify other shareholders, in the event of a voluntary termination.
- Trailer provisions to protect exiting shareholders, in the event of a subsequent liquidity event.
- Discounts on value or extended payment terms for non-compliance of notification provisions.
- Insurance portability provisions to allow existing shareholders to reassign beneficiary designations (once payments owed to the exiting shareholder have been made).
- A graduated buy-out plan, such as an installment purchase agreement, or a purchase funded with life insurance on the first partner to die.
Businesses are dynamic entities with frequent changes, so buy-sell agreements should be reviewed and updated in the same way that an estate plan needs to be updated—every three or four years.
To learn more about business estate planning for business owners, check out these articles: Estate Planning for Your Business and What to do If Someone Wants to Buy Your Business and What Is Family Business Succession Planning?
Reference: Philadelphia Business Journal (Sep. 1, 2021) “Why does your business need a buy-sell agreement?”