Buy-Sell Agreements: Protecting Your Business from Life’s Many Changes
As you begin building your business, you may not think about putting protections in place should something happen to one of your business partners—or you. Investing time now to create a buy-sell agreement can help to avoid putting your dreams at risk.
What is a buy-sell agreement?
A buy-sell agreement is a crucial tool for businesses, especially those with multiple owners. Think of it as a “business prenup” or a “business will,” says SCORE, a national nonprofit dedicated to helping small businesses get off the ground, grow, and achieve their goals. The buy-sell agreement ensures business continuity and protects stakeholders in the event of a partner’s death, disability, retirement or divorce, or any other matter that could complicate the business’ smooth operation.
How does it work?
The buy-sell agreement sets up safeguards and outlines how various scenarios can be resolved for the remaining owners and the business. The agreement spells out, among other items:
what triggers a buyout
who can (and cannot) buy a partner’s share of the business
the plan for the orderly transfer of ownership
provisions for resolving disputes among the owners
a method for determining the fair market value of the business at the time of a triggering event
what happens to your business assets for the benefit of your loved ones should something happen to you
What type of buy-sell agreement do you need?
The type of buy-sell agreement you will need depends on various factors, including the number of owners, the nature of the business, and the owners' preferences and financial capabilities; however, there are two primary types:
Cross-Purchase Agreement. Each business owner agrees to buy the interest of a departing or deceased owner. This type of agreement is common in smaller businesses with a limited number of owners. Each owner typically purchases life insurance on the lives of the other owners to fund the buyout.
Entity Purchase or Stock Redemption Agreement: In an entity purchase agreement, the business entity itself agrees to purchase the interest of a departing or deceased owner. The company typically buys life insurance policies on the owners to fund the purchase. Alternatively, in a stock redemption agreement, the company buys back the departing owner's shares.
Who should I work with to craft a buy-sell agreement?
Financial advisors with expertise in the business owner market should be your go-to guide for this process. They will ensure to bring your attorney into the conversation, and your CPA as needed, to properly craft the details and structure the funding.
Putting a buy-sell agreement in place is smart business to mitigate issues down the road and ensure the continuity of your company no matter what happens in the personal lives of you and your partner owners.
