If you’re involved in a small business, you may have had the worry in the back of your mind, “What happens if this business owner dies?” The business owner may be you, or it may be a close friend. In family businesses, the owner’s death could be devastating both personally and to the business. One option for protecting small businesses in such a scenario is a buy-sell agreement.
What is a Buy-Sell Agreement?
Think of a buy-sell agreement as the business equivalent of creating your own will. A will is a document that outlines what you want to happen to your belongings when you pass away; a buy-sell agreement details what would happen to your share in the business should you leave the company. Some people even call buy-sell agreements “business prenups.” These types of agreements are commonly made for closed corporations, privately held businesses, sole proprietorships, and partnerships.
Why would I need a buy-sell agreement?
Buy-sell agreements have value for several different scenarios. Their main purpose is to protect the business in case a key person in the organization leaves. Reasons for leaving are usually categorized as either involuntary or voluntary. Involuntary reasons for leaving include death, severe injury, mental incapacitation, or bankruptcy. Voluntary reasons may include retirement or leaving the company to pursue another opportunity. No matter how thoroughly you plan for your business, you can’t control other people, and there are always some events that you can’t predict. These sudden life occurrences can leave you emotionally and financially in shambles. That’s where buy-sell agreements come in.
When someone with a significant role leaves the company, the remaining business partners may want a say in what happens to the rest of the company. There are two types of buy-sell agreements to address this: a cross-purchase agreement and a redemption agreement. A cross-purchase agreement allows other business partners to purchase the share of the business that is left available. In a redemption agreement, the business entity itself has the option to purchase and absorb the remaining share.
You can also create an agreement that combines the two types. By planning for the future, you buy-sell agreement can make business transitions much easier, avoid deadlock, and protect original members of the organization.
What does a buy-sell agreement entail?
A buy-sell agreement stipulates what would happen to the equity interests of a privately held business if a key person leaves the business. Here are some items you may consider including in your agreement:
- How you want to determine the value of a person’s share of the company, including company stock and fair market value of assets
- Life insurance policies for key employees
- Right of first refusal so existing business partners can choose to buy the open share and block third parties from entering the business
- Tax considerations for company investments
- Supplemental payments to the former partner and/or their family members
How to Start
Depending on how complex your business needs are, you may need to consult a lawyer to help you draft an agreement. However big or small your business is, though, you should certainly consult with a financial advisor. The future of your business is important to protect.
A buy-sell agreement can also tie into your retirement plans and life insurance policies, so it’s important to include in your overall financial picture. Advice Chaser can connect you with a financial advisor who has specific experience with buy-sell agreements. To get matched with an advisor, contact us today.