You and your partners didn’t start your business with the idea that one day, circumstances would result in one of you exiting the firm. But life doesn't care what kind or how successful a business is, sometimes misfortunes happen that cause your plans to change. Your best preventative defense against a whirlwind of unpleasant outcomes can be found in a buy-sell agreement.
What is a Buy-Sell Agreement?
Simply put a buy-sell agreement is a legal document that covers contingency plans on what happens to a business if one owner is divorced (and forced to liquidate their ownership), becomes disabled, or dies. This document is designed to ensure that any partners’ shares can be bought by the other partners in the business. This protects everyone—both the partner who is unable to continue in their role as well as the other partners. A buy-sell agreement ensures that the major contributors of the business’s hard work will continue long after they are able to be involved.
Should I Have a Buy-Sell Agreement?
If you are in business with others, you will definitely need a buy-sell agreement. It will outline all the rights every owner has in regards to the progression of the business. A buy-sell agreement will give you and the other business owners many opportunities to ask questions and provide answers. You and the other owners can decide on the right steps to take if a conflict arises and no solution can be made. Even if you are the only person who owns the business, a buy-sell agreement is still an important document to have. What if you eventually want to leave your business to one of your most trusted employees when you die? If you have drafted a buy-sell agreement, the employee can buy your business, and the money will be paid to those you have left behind.
Why is a Buy-Sell Agreement Necessary?
Simply put, one has to plan for every possibility. Let’s take a look at the possible scenarios that could disrupt a business:
One Partner Divorces – as part of a divorce settlement, one of the aspects of property division could include your business. In effect, this could result in a partner being forced to either sell their portion of the business or give up a portion to their spouse. Having a buy-sell agreement in place sets up a scenario where other partners can buy out the portion of the business that is involved in a divorce settlement.
One Partner Becomes Disabled – if a partner becomes disabled, someone in their family may have control over their finances. This can happen in one of two ways—a pre-existing power of attorney or a court appointed power of attorney. In either case, someone who has no knowledge of your business could be making decisions on the partner’s behalf. A buy-sell agreement can address this contingency.
Death of a Partner – losing a partner to death is devastating because you have established a working relationship. However, you could be facing problems with your business whether the partner died with or without a will. In many cases, the ownership portion of the business will transfer to a spouse or children of the partner meaning your business is now partially controlled by a stranger. A buy-sell agreement can provide for this type of contingency by ensuring the family is bought out and the business continues to be controlled by those who have a vested interest and knowledge about the business.
How Does Life Insurance Play a Role In Buy-Sell Agreements?
For larger businesses with more than two or three owners, such as an LLC, C Corp, or S Corp, a different buy-sell strategy called a cross purchase agreement, can be effectively implemented. This buy-sell agreement strategy requires the business insurance to be taken out on all the owners and makes the business both the owner of the policy and the beneficiary.
Still not sure if you need a buy-sell agreement? Even the best of partners should consider the possibilities that the future holds. Some of the most common reasons why partners do not get a buy-sell agreement are:
We’re busy entrepreneurs. Our focus is getting our new business up and running.
Entrepreneurs work hard to start up and grow their new business. All the hard work, joint energy, and enthusiasm the partners share should be rewarded with a solid operating or partnership agreement that includes a just-in-case buy-sell plan that protects the partners and the new enterprise over time.
My partner(s) and I are on the same page. We trust each other.
Yes, for now. But partnerships are like marriages: some last forever and some do not. One partner eventually may want a “divorce” from the company at some point—or may go through an actual divorce and need to divest his or her company shares. How would you feel about a partnership with the spouse, which may happen if a judge awards your partner’s shares to the spouse upon dissolution of the marriage?
We will just talk it through when the time comes.
That works—barring an unforeseen disagreement, dire illness, accidental death, or some other life intervention that would preclude your ability to discuss a transfer of partnership shares amicably, or at all. Putting off developing a buy-sell agreement creates risk for you, your partner(s), and the enterprise itself.
Consult with our CPA Firm
Planning for the future of your business is worth the time and the investment. Knowing that you are prepared for any situation will give you peace of mind. We see all to often that the excitement of starting a new business or taking on a new opportunity pushed out the more negative thoughts of “what if”, but those are exactly the thoughts that should be addressed first. We want to see your business grow, but we also want to make sure that you’re protected in case of life’s mishaps. Chandler & Knowles understands how important buy-sell agreements can be to the overall success of your business. We know that succession planning is an important part of your business and we can help you design an effective plan based on your overall goals and your corporate structure. Contact Chandler & Knowles, CPAs for help ensuring your business transitions smoothly in the event of life-changing events.