Why Your Business Needs a Buy-Sell Agreement
There is a lot of planning that goes into starting a business, however, one thing owners may not consider is what happens to the business if you retire, move on, become disabled, or die.
Buy-sell agreements help business owners prepare and easily address potentially difficult scenarios to allow for an orderly transfer of ownership, and they protect the company and each owner’s interests. Many business owners appreciate making decisions regarding the transition of ownership upon death or disability while they are alive and not leaving it for their families to deal with.
A buy-sell agreement is a legally binding contract among the owners of a business that stipulates how an owner’s share of a business may be transferred if that owner dies, becomes disabled, or otherwise leaves the business.
Buy-sell agreements should be periodically reviewed and revised as circumstances surrounding the business and the owners change. It is important to note that owners are always free to agree to terms that are different than as provided in the buy-sell agreement, however, if they cannot agree, the terms of the buy-sell will control.
There are two primary types of buy-sell agreement: (1) a redemption agreement and (2) a cross-purchase agreement. In a redemption agreement, the company buys the owner’s interests in the business. In a cross-purchase agreement, the remaining owners purchase the owner’s interest in the company that is for sale. The most common type of buy-sell that businesses choose are cross-purchase agreements, however, there can be a combination of the two.
A buy-sell agreement typically covers three types of transfers: (1) transfers during lifetime; (2) transfers upon death; and (3) transfers upon disability. Under each section, the agreement will provide the nature of the buy-out (either mandatory or optional), the price, and the payment of the purchase price.
Transfers During Lifetime. This section of the buy-sell will protect both the rights of an the owner who wishes to sell his or her interest against and the rights of the other owners to choose their partners.
Transfers Upon Death. Depending upon each individual business, most owners tend to lean toward having, upon the death of an owner, the remaining owner’s purchase the deceased’s interest and pay the purchase price to the decedent’s estate. In regard to paying the purchase price, life insurance policies can be taken out to cover the purchase price in the event of death.
Transfers Upon Disability. In the event an owner becomes disabled and unable to perform his or her daily duties, it is important to have an agreement regarding the rights and obligations of the disabled owner and the non-disabled owners to force a buy-out of the disabled owner’s interest.
Purchase Price. The purchase price for buy-outs is typically determined after discussion among the owners and consultation with the company’s accountant. Valuation options include fixing a price, choosing a formula to be used to determine the price, and having the price determined by an appraiser. Another item that may be decided is the a payment schedule in order to determine how payments will be made to the selling, deceased, or disabled owner.
If you are a business owner and would like to begin the preparation of a buy-sell agreement, or if you have a buy-sell agreement that has not been updated in a while, please call any of the business lawyers at Kahan Kerensky Capossela, LLP.