Plan for Business Ownership Transitions with a Buy-Sell Agreement
If you’re a co-owner in a business partnership, closely held corporation, LLC, or other joint venture, consider what would happen if you or one of your co-owners suddenly left the business, became disabled, or suffered an untimely death. For example, what would happen if a co-owner died unexpectedly? Would you be forced to work with his or her spouse or other heir? Or, if you died, could your family get a fair price for your interest in the business? Leaving such issues unresolved can result in financial problems and hardship for the co-owners and the business itself. Fortunately, you and your co-owners can settle such issues in advance with a document known as a buy-sell agreement.
What is a buy-sell agreement?
Sometimes referred to as a prenuptial or premarital agreement for business owners, a buy-sell is a legally binding contract that establishes to whom, under what circumstances, and at what price a co-owner can sell his or her business interest.
Describes to whom …
There are different types of buy-sells. Each type describes how an interest can be sold in a slightly different way, depending on the form of the business entity and the co-owners’ goals. The common element among the different types of buy-sells is that the co-owners are prevented from selling to outsiders without the consent of the other co-owners. For example, with a buy-sell known as a cross purchase plan, a departing co-owner agrees to sell his or her interest to the remaining individual co-owners. With a stock redemption plan, used by closely held corporations, a departing co-owner (shareholder) agrees to sell his or her interest to the corporate entity.
Of course, funds must be available to buy a departing co-owner’s interest. One way this can be accomplished is through the purchase of life and disability insurance policies on each co-owner.
… under what circumstances …
Events that trigger a buy-sell typically include the death or disability of a co-owner, but could also include a co-owner’s retirement, divorce, receipt of a third-party offer to purchase, or any other circumstances that you anticipate would be disruptive to the business or cause hardship to the co-owners.
… and at what price a business interest can be sold
A buy-sell also spells out how interests will be valued when they are sold. You and your co-owners decide in advance how a reasonable price for the business will be calculated. There are different valuation methods from which to choose, including book value, appraised value, and capitalized earnings.
Smoothing the way
A buy-sell agreement can protect a business and its co-owners against problems that might occur due to a change in ownership. A proper buy-sell will provide for an orderly transition of ownership, prevent unwanted co-owners, establish a fair value for the business, and guarantee buyers for the business interests.
The decisions you need to make when creating a buy-sell that works for you are numerous and can be complicated. Your financial professional can help.