Buy/Sell Agreements

Buy Sell Agreements

Starting a business is an exciting time for every entrepreneur. The future looks bright and it seems anything is possible. In this time of new partnership and collaboration, amidst the brainstorming and decision-making, one thing generally doesn’t come up: planning for a dramatic shift in the ownership.

In a recent blog post, we highlighted how Key Person Life Insurance can be an integral part of a business’ long term strategic planning. Another very important consideration for the survival of a business is a buy/sell agreement. Basically, a buy/sell agreement outlines the disposition of ownership interest under certain circumstances. A recent study by Massachusetts Mutual Life Insurance Company revealed that only 44 percent of business owners surveyed have a buy/sell agreement in place.

Understand the Benefit

Buy/sell agreements help to address these scenarios before they threaten the business.

  • Death – When an owner dies, what happens to their share of ownership? A life insurance policy can serve as the funding vehicle for the buy/sell agreement to buy the deceased owner’s share; otherwise, the business may revert to an heir or spouse who has neither the desire nor skills necessary to run the business.
  • Disability – Should an owner or shareholder become disabled and unable to work, the remaining partners could be left with an obligation to continue salary and/or profit-sharing for someone who is no longer able to contribute to the business. Here again, your insurance agent can help you transfer this risk with a disability insurance policy, or disability buy-out policy.
  • Divorce – When an owner divorces his or her spouse, the former spouse can lay claim to a portion of the business. While insurance doesn’t play a role here, it can be useful to know what would happen in the event a partner’s marriage ends.
  • Disagreements, defaults, deadlocks and departures – There are plenty of reasons why an owner or shareholder may leave a business or otherwise need to dissolve their portion of the ownership. If an owner leaves the business either voluntarily or involuntarily, his or her interest in the business should be purchased by the other partners, but exactly how these scenarios will be handled can be addressed in a buy/sell agreement.

A buy/sell agreement can also serve as a useful tool in estate planning to avoid costly estate taxes if the business is passed to the estate rather than bought by a new owner. There are guidelines set forth by the IRS in terms of what it finds acceptable and careful attention must be paid to ensure the agreement is drafted properly.

Buy/Sell agreements can also limit the ability of a partner or shareholder to sell or otherwise transfer their share of ownership to a person outside of the agreement. This prevents one person in the organization from unilaterally deciding future ownership of a business without consulting other shareholders. It’s impossible to know the future, so writing a plan of action while all partners are on solid ground with the best interest of the business at heart can stop any ill-will before it starts.

Consult the Right Experts

In order to formally adopt a buy/sell agreement, you’ll need an attorney who understands the nuances of your business and your relationships. A poorly designed agreement can result in a situation where partners may attempt to use it against one another or it will not take into consideration all possible scenarios.

The right accountant or business appraiser can help determine the value of the business, as it is crucial to outline the purchase price based on the various possible events. This valuation should be repeated periodically to account for changes to the business itself, the specific industry within which the business operates, and economy on a national and global scale.

Your insurance agent can help to recommend the right products to fund portions of your agreement since relying upon cash, savings, or an intention to borrow can lead to an absence of funds when they are needed the most. We have the carrier relationships to provide you with the help you need, including access to resources such as accelerated underwriting, business valuation services, and reviews of existing, and possibly outdated, buy/sell agreements.

Business Protection Before You Need It

Think of a buy/sell agreement like a prenuptial agreement. Drafted properly, it can prevent a whole host of issues that can arise from the death or departure of a partner. Without one, everything a company has built, possibly over generations, can be lost with one unfortunate event. If you’re going to invest in growing your business, you need to invest in transitioning it, too.

All insurance policies are different. Be sure to review your insurance policy for specific information about coverages available to you. Nothing in this post is meant to suggest a guarantee of coverage.