Understanding Buy and Sell Agreements
A buy and sell agreement, also known as a buy-sell agreement, is a legally binding contract that outlines the procedure for redistributing a business partner’s share of the company upon their exit or demise. Often equated to a business will or a corporate prenup, these agreements are essential in preempting potential disputes and ensuring business continuity.
How It Works: The Mechanics of a Buy-Sell Agreement
Buy-sell agreements serve as a fail-safe for businesses, particularly sole proprietorships, partnerships, and closely held corporations. The agreement sets forth a predetermined formula for the sale of the business share to the company or remaining members when a partner departs by choice or chance.
Funding for these purchases often comes from life insurance policies taken out by each partner on the others, which are considered a business expense. This setup ensures that on the death of a partner, the payout from the life insurance allows the surviving partners to buy out the deceased partner’s share, circumventing potential legal wrangles with heirs and preserving the business structure.
Types of Buy-Sell Agreements
Three main types of buy-sell agreements exist, each catering to different business needs:
- Cross-Purchase Agreements: Allow remaining owners to buy the shares of the departing owner, fostering direct ownership transitions.
- Entity-Purchase (Redemption) Agreements: The business itself purchases the departing owner’s share, centralizing the business ownership.
- Wait-And-See Agreements: A hybrid approach where the decision between cross-purchase and entity-purchase is deferred until the actual occurrence of an ownership change.
Key Considerations for Effective Agreements
To forge a robust buy-sell agreement, several factors need consideration:
- Valuation of Shares: The agreement must clear the method for valuing the business and its shares, an important determinant in the transaction.
- Funding Sources: Life insurance is a popular choice, but the agreements may include other funding mechanisms like sinking funds or loans.
- Legal and Tax Advice: Involvement of attorneys and CPAs ensures that the agreement complies with current regulations and offers tax-efficient transfer of ownership.
Books for Further Reading
To dive deeper into the intricacies of buy-sell agreements and related planning strategies, consider these resources:
- “Business Buyout Agreements: Plan Now for All Types of Business Transitions” by Bethany K. Laurence & Anthony Mancuso.
- “Succession Planning for Family Businesses: Preparing for the Next Generation” by Michael Farrell.
By outfitting your business with a thoughtfully structured buy-sell agreement, you not only safeguard against unforeseen changes but also consolidate the foundation for enduring success and harmony among business partners. The peace of mind knowing that your business legacy is protected is indeed priceless—because after all, forewarned is forearmed, and in business, it’s equivalent to being four-armed!
