If business partners had a special knack for seeing into the future, and avoiding issues that can destroy a business, they would surely draw up a buy-sell agreement long before one of the partners dies, retires, becomes disabled or suddenly chooses to leave.
Without the legal contract, they will struggle to keep a clear head while making big decisions in the best interest of the company during the emotional time.
They will also worry about questions such as who can buy into the business, how to avoid a forced sale or expensive litigation, and how to get their fair share of their time and investment in the company.
A buy-sell agreement is one of several key components of an exit-strategy, or succession planning, along with an updated business valuation and a way to fund the transition.
Yet a significant number of business owners don’t have one. Only 58 percent of family businesses have a succession plan, and most of them are informal, according to a US Family Business Survey released earlier this year (209) by PwC, an international business, tax and consulting firm.
Specifically, a buy-sell agreement will identify:
- The parties to the agreement
- The purchase price, or a formula to determine the price
- The terms of the agreement
- Funding arrangements, such as loans, equity financing, a term life insurance policy, cash reserves, or a payment schedule
- An updated valuation
Usually, a buy-sell agreement requires the retiring or disabled owner (or owner’s estate) to sell the business to the business itself, the surviving owners, a third-party non-owner, or a combination of parties.
Reputable legal, business and financial advisors can help business partners draw up a buy-sell agreement that protects everyone involved. The best agreements will help owners avoid entanglements, like the impact of an individual partner’s divorce or personal bankruptcy, and reduce tax liabilities on surviving owners who purchase the retiree’s interest.
They buy-sell agreement allows the business to move forward, reduces risks that could harm or destroy the business down the road and protects owners’ families if a partner dies or becomes disabled.
Here are some other important issues to consider when drawing up a buy-sell agreement:
- Businesses evolve over time, which may require updates or changes to certain contract agreements.
- Consider a business valuation clause that identifies how an expert will assess the value of the business. Should the expert use market-based, income-based or total-asset-based approaches?
- Make sure the business assessment is based on the company’s unique characteristics rather than one of the owner’s special formulas.
- Determine the ground rules for what may trigger a sale, who can or can’t buy into the business (family members?) and how a business sale will be funded, such as cash, debt or insurance proceeds.
- Structure the contract to minimize the retiring owner’s taxes or allow them to be paid over time so the retiree doesn’t encounter drastically reduced proceeds.