Estate Planning For Your Business: Do You Need a Buy-Sell Agreement?
by Tamika Johnson
A buy-sell agreement is a legally binding contract stipulating how a partner's share of the business may be reassigned if that partner dies or otherwise leaves the business. The agreement establishes a method for determining a business's value, letting the available share be sold to the remaining partners or to the partnership.
You may want to write this business prenup before putting money into a venture. As the agreement is a binding contract between co-owners, it controls when owners can sell their interests, who can buy an owner's interest and what price will be paid.
When do these agreements come into play? When an owner:
- Goes bankrupt.
- Becomes disabled.
- Gets divorced.
- Passes away.
Here are some specific situations in which buy-sell agreements can help:
- When a former spouse of a divorced owner wants to sell back any interest received in a divorce settlement to the company or to other owners. With the agreement, there's a valuation method provided.
- To prevent a business from getting tied up in bankruptcy court. The agreement can require the co-owner facing bankruptcy to notify the other owners before filing, stipulating an automatic offer to sell the bankrupt owner's interest. The buyout money goes to the bankruptcy trustee and the business proceeds without difficulties.
How is the value of the firm determined? The partners can hire a professional appraiser or use a valuation formula to come up with a price using financial statements from one or more years. This helps the owners agree on a way to value the company in advance. Deciding on a sound method beforehand can go a long way to reducing conflict when the time for a buyout comes.
The buy-sell agreement requires that the business share be sold to the company or the remaining members of the business according to a predetermined formula. When a partner dies, the estate must agree to sell.
There are two common forms of agreements:
- A cross-purchase agreement — the remaining owners purchase the share of the business that's for sale.
- A redemption agreement — the business entity buys the share of the business.
You also can use a mix of the two — some portions are available for purchase by individual partners and the remainder is bought by the partnership. Partners in a business commonly purchase life insurance policies on the other partners. Proceeds from the policy would be used to purchase a deceased partner's interest.
- Allow a key employee to buy the share.
- Restrict owners from selling their interests to outside investors without the approval of the remaining owners. Prevent the estate from selling the interest to an outsider.
Buy-sell agreements can be crafted with the help of an attorney and a CPA, especially if the requirement of an immediate, 100% lump-sum cash payout prevents the company from buying back an owner's interests. Build-in flexible payment terms in advance. Every day that value is added to a business without a plan for a future transition, financial risk increases. Don't put yourself in jeopardy by delaying.