Business Owners: Learn Why You May Need a Buy-Sell Agreement
If you own a business, there’s a good chance you’ve thought about what might happen in the event you either choose to leave, or can no longer run it. But a Buy-Sell Agreement can give you peace of mind, while making it feasible for others to carry on smoothly.
Here’s a quick overview of how it works, and why you might want to consider it:
How Buy-Sell Agreements Work
What exactly is a Buy-Sell Agreement?
It’s a legally binding contract that outlines terms and conditions for a future sale of the business – or for a buy-back of an owner’s shares if he or she leaves. The agreement controls:
- when owners can sell their portions
- who can buy them, and
- what the price will be
What are other names for this agreement?
You may have heard them called Business Continuation Agreements, Stock Purchase Agreements, or Buyout Agreements.
When do Buy-Sell Agreements actually get used?
Things that can trigger a sale of the business (or a particular owner’s interests) usually include:
- Death or long-term disability
- Personal bankruptcy
- Criminal conviction or loss of a professional license
- Resignation or firing
In some cases, Buy-Sell Agreements can offer co-owners the right to force an owner out of the business, or let an owner force his or her partners to buy him or her out.
How is a Buy-Sell Agreement typically structured?
There are four common approaches:
1. Entity Purchase Buy-Sell – requires the business itself to buy the interests of each departing or deceased owner.
2. Cross Purchase Buy-Sell -- Each indidivudal owner agrees to buy a share of a departing or deceased owner's interest.
3. One-Way Buy-Sell – Typically used when a sole owner is planning a sale to a family member or key employee.
4. Wait-and-See Buy-Sell – Used when potential buyers aren’t sure if they’ll want to buy out when the time arises.
Financing a Buy-Out
The buyer of an owner’s shares can finance their buy-out in a variety of ways, including:
- Paying in Installments
- Private Annuity
- Stock Redemption
- Life Insurance
Planning will need to be done ahead of time, so that the buyer is not forced to make a purchase that he or she cannot reasonably fund.
Benefits of Implementing a Buy-Sell Agreement
There are several key advantages to having this document in place:
- It helps ensure that the business can keep running smoothly after an owner’s retirement, death, or unexpected inability to work.
- It makes succession of a family business easier.
- It offers financial liquidity to pay a deceased owner’s estate costs and taxes.
- It can also establish the purchase price as the taxable value of an owner’s interest so that estate taxes are known and expected.
Are there any drawbacks to a Buy-Sell Agreement?
Any potential “downsides” are usually outweighed by the many benefits of a Buy-Sell Agreement. But there are a few things to keep in mind:
- The sale will have to be at the price established by the agreement – even if the actual value is higher by the time it happens.
- Most agreements will place some type of restriction on lifetime transfers.
- When family members are involved, the transaction needs to be demonstrated as comparable to what it would be for a sale to any unrelated individuals. Note: An independent business assessor needs to determine the fair market value for Buy-Sell Agreements.
Want to learn more?
Horizon Bank advisers are always here to provide you with valuable insights and Sensible Advice about your business needs. Reach out to us any time!