Creating a buy-sell agreement for a business owner is a lot like a will—it needs to be updated to reflect changes in partnership agreements or the departure of the owner or a co-owner from the business. As reported in Country Journal’s article, “Drafting and reviewing your buy-sell agreement,” a buy-sell agreement is one part of a larger process of estate planning.
The idea behind a buy-sell agreement is to legally confer on the owners of a business or the business itself, the right or obligation to buy a departing owner’s interest. However, a professionally drafted agreement can also dictate that control of the business is restricted to specified individuals, like the current owners or a family member. In addition, a buy-sell agreement can set a price for the ownership interests. Finally, estate planning is also a top issue for many buy-sell agreements.
A buy-sell agreement can lie dormant for years, then a “triggering event,” like the retirement or death of an owner, brings the buy-sell agreement into play. However, other events like changes to marital status can also trigger the document, too. A buy-sell agreement can also address events like a criminal conviction, the loss of professional licensure or certification, or involvement in a situation deemed to be inappropriate or illegal.
If you haven’t drafted a buy-sell agreement for your business with your lawyer, you can now see the importance of doing so. Here are the structures and options for agreements:
- Redemption—permits or requires the business as a whole to repurchase an owner’s interest;
- Cross-purchase—permits or requires the remaining owners to buy the interest (usually pro rata), and
- Hybrid—combines the two other structures. For example, it might require a departing owner to first make a sale offer to the company and, if it declines, sell to the remaining individual owners.
You should also consider the tax implications when you draft your buy-sell agreement and its initial structure, because taxes will differ based on whether your company is a flow-through entity or a C-corp.
Buy-sell agreements need a funding source so the remaining owners can buy their former co-owner’s shares, and life insurance is commonly used. However, there are alternatives. A cash-rich company that’s confident in its future, could rely on its reserves. This could leave a business vulnerable to an unexpected cash shortfall. A “sinking fund” is another option. You set aside money for paying out the agreement over time.
The creation and updating of a buy-sell agreement does have associated costs, but if a triggering event occurs, it will more than pay for itself in both cost, time and stress.
Kevin D. Quinn of Legacy Counsellors, P.C. assists business owners every day with creating an estate plan that includes business succession planning. If you are a business owner in need of a plan, please contact us today.
Reference: Ohio’s Country Journal (June 14, 2017) “Drafting and reviewing your buy-sell agreement”