Thursday, November 11, 2010
Importance of a Buy-Sell Agreement
For businesses with more than one owner, the importance of a buy-sell agreement cannot be overstated. Events such as the death, incapacity, retirement or even divorce of one of the owners (“Triggering Events”) can sink a business if the owners have not entered into a buy-sell agreement. Unfortunately, most small business owners do not have this vital agreement in place.
Many concerns arise when there is an unforeseen change in ownership. For the remaining owners, the most common concerns are 1) being forced to work with the departing owner’s successors, who may have potentially conflicting ideas; and 2) finding a source of capital to fund a significant buyout. And for the departing owner, the primary concerns are 1) ensuring his or her family is compensated fairly for their share of the business; and 2) providing funding for the family to pay potential estate taxes. A properly drafted buy-sell agreement can address each of these concerns.
Among other things, a buy-sell agreement can accomplish the following:
• Upon the occurrence of one of the above mentioned Triggering Events, owners are guaranteed their interest in the business will be purchased. A buy-sell agreement can also provide for optional buy-outs when a member wants to retire, wants to sell their ownership interest to a third party, declares bankruptcy, or has a court order affecting his or her ownership interest in the company.
• Provide that the departing or departed owner’s interest must be sold to the company, to the remaining owners, or a combination of the two;
• Provide a mechanism whereby the purchase price may be determined by agreement amongst the owners or by market conditions;
• Provide a funding source, primarily through insurance policies, so that the company can maintain its cash flow and the departing member’s family can be compensated fairly; and
• Establish a valuation of a deceased owner’s interest in the business for estate tax purposes.
Executing a carefully planned buy sell agreement can assure business owners that their ownership interest in their business is secure, regardless of any unforeseen circumstances. In many cases, this can be accomplished without putting excessive strain on the business’s cash flow, ensuring that the business and its remaining owners continue to succeed as well.