One of the most common business succession planning strategies for businesses with multiple owners is a buy/sell agreement.
This agreement is a legally binding contract that describes how an owner’s interest is to be reallocated following a triggering event, such as an owner’s retirement, death, disability, bankruptcy, or a decision to leave the business.
The buy/sell agreement may include an agreed-upon sale price, the value of each owner’s share, and any restrictions regarding who can or cannot be a buyer. Other owners will have either the option or the obligation to purchase another owner’s shares following a triggering event. These types of provisions protect the business ownership from outsiders or undesirable partners. This may be especially useful in a family business.
The owners will need to identify their desired successor(s) before drafting the agreement. This could be an existing co-owner, a family member, a key employee, or an outside third party. Each option has advantages and disadvantages. It’s important to thoughtfully consider all available options and choose the best fit for your business.
A well-structured buy/sell agreement will include covenants to protect the business and the owners. This may include items such as non-compete clauses for the selling party, a personal guaranty by the remaining owners, limitations on compensation during an installment sale period, consistent reviews of financial statements, etc.
The most common types of buy/sell agreements are:
- Cross-Purchase – Each owner agrees to purchase the other’s business interest following a triggering event.
- Stock Redemption – Each owner agrees to sell his or her ownership interest back to the business following a triggering event.
- Combination Agreement – Each owner has the option to either sell his or her ownership back to the business, or to the other owner(s) following a triggering event. This is the most flexible option and may help ensure shares remain with the original owner(s) of the business.
A business valuation will be needed to determine the appropriate amount required to fund the
buy/sell agreement. Depending on the type of business, this could be done by a Certified Public Accountant, an independently qualified appraiser, or even an arbitrary agreement between all owners. For a publicly traded company, valuation can be based on the current market price of the stock.
It is imperative to reevaluate the business valuation over time to ensure the agreement remains properly funded.
For the buyer of your business, having enough cash on hand to complete the purchase can be difficult. Because of this, several options exist for structuring a buy/sell agreement, including installment sales, acquisition loans or life insurance. The most effective and efficient option for a buy/sell agreement is life insurance, since it provides liquid, tax-free assets quickly after the death of an owner. Permanent life insurance policies would include the option to withdraw the cash value or take a policy loan, if needed.
Having a well thought out buy/sell agreement in place is imperative for the successful and efficient transition of ownership of a business. Engaging a professional team with the expertise to help you structure your buy/sell agreement properly is equally important. Planning for the logistics of a future transition can also bring peace of mind, knowing that your business and your family will both be taken care of in the event of unexpected death or disability.
Important Disclosures: Nothing in this document is intended to provide, and you should not rely upon it for, accounting, legal, tax, insurance or investment advice or recommendations. We are not making any specific recommendations regarding any business succession planning or insurance policies, and you should not make any investment or purchase of insurance policy decisions based on the information in this document. The intention of this document is educational, and it is intended only to discuss limited aspects of business succession planning and insurance policies in general terms. This document is not a comprehensive or complete summary of considerations regarding business succession planning and insurance policies. Each individual is in a different situation and has different items to address, and the options in this document are not appropriate for everyone. Please consult your financial advisor and tax professional or attorney regarding options specific to your needs.