Buy Sell Agreements for closely held and family business owners is a legal document that establishes a market for your business in the event of a “triggering” event. Triggering events may include the untimely death, disability, or retirement of a business owner.
Have You Ever Considered:
- What would happen to your business if you or one of your partners were unable to work ever again?
- If something were to happen to you are their family members, employees, or heirs who could successfully run your business?
- Do any of your family members, employees, or heirs even want to be involved with the business?
- If one of your partners is unable to work, could you successfully work with their family members or heirs on an ongoing basis?
- Do you or your partners have the financial ability to purchase the business interest of a deceased or disabled owner?
- Has a fair purchase price for each owner’s business interest been established if a buyout were to occur?
For most closely held business owners the business is their primary source of income. It can also be a significant portion of their estate.
The death or disability of the owner of a family-owned or closely held business can have a devastating financial impact to their family and any remaining owners (if any).
A properly executed buy-sell agreement can be one of the most powerful tools for managing the transition of company ownership when a “triggering” event occurs. It allows business owner(s) to determine how the business will transition before a “triggering” event occurs.
When done correctly, a buy-sell agreement for closely held businesses will ensure the business is able to continue with the surviving owners while providing financial security for the deceased or disabled owner’s family and heirs.
What is a Buy-Sell Agreement?
A buy-sell agreement enables business owners or the entity the ability to purchase the ownership interest of an existing owner when a triggering event occurs. Triggering events can include voluntary events like retirement or involuntary event such as death, disability, divorce, bankruptcy, etc.
A buy-sell agreement for closely held businesses can also restrict outsiders or undesirable business partners from becoming owners. It also gives the remaining owners the first right of refusal to purchase the exiting owner’s business interest.
There are different types of buy-sell agreements for closely held and family-owned businesses. They include a Stock Redemption or Entity Purchase Plan, Cross Purchase Plan, Cross Endorsed, and One Way Buy-Sell Agreement.
There are a number of factors to consider when deciding which type of buy-sell agreement makes the most sense for your situation. It is important to work with an attorney or accountant to determine what type of buy-sell agreement is right for you.
The ideal arrangement is going to depend on factors that are unique to your business, such as what is the business structure (e.g. Sole Proprietorship, C Corp, S Corp, LLC, etc.) and the number of owners.
How Does a Buy Sell Agreement Work for a Family Owned Business?
The way to structure a buy-sell agreement for a closely held or family-owned business is going to vary based on the number of owners. In some cases, you will have one person who owns 100-percent of the business. In other cases, you may have two or more owners. These and other factors will help assist in structuring the buy-sell agreement.
When only one owner exists, it is important to identify a successor. This may be a family member or an unrelated key employee. Ideally, it is a person who can continue to manage and run the business in the event a triggering event occurs with the business owner.
Once the candidate is identified it is then time to work with an attorney to structure the agreement to include any caveats that make the most sense for your situation. This is generally referred to as a One-Way Buy-Sell Agreement.
This occurs when the sole owner of a business designates a key employee or family member as their successor. Under this scenario, the family member(s) or key employee(s) will need to understand and agree to the terms of the agreement.
It is also important to understand the financial component of the agreement. How will the family member(s) or key employee(s) be able to purchase the company from the owner or the owner’s family?
Will it be through some type of installment sale using company profits over a period of time? Will they be able to secure a bank loan for the buyout (not likely)? Does securing life insurance on the owner’s life to provide a lump sum payment for the purchase price make sense?
These are all different scenarios a 100-percent owner of a business needs to consider. This will provide a fair and equitable price for the value of the business and will allow for the orderly transfer of ownership.
Why Do Buy Sell Agreements for Closely Held and Family Business Owners Make Sense?
A buy-sell agreement offers owners of a business several benefits. A properly executed buy and funded buy-sell agreement provides a market for the sale of the business for a departing owner and/or their heirs.
When using life or disability insurance to fund a buy-sell agreement it creates access to immediate cash to provide for estate liquidity or other family needs while relieving the departing owner and/or heirs with the ongoing responsibilities of the closely held business.
By using life insurance, the buyer of the departing owner’s business interest will have the cash to satisfy the purchase obligations created by the buy-sell agreement.
Four Reasons Why You Need a Buy-Sell Agreement for Your Family Owned Business
One: It Establishes a Fair Selling Price for the Business
Establishing a fair selling price while everyone is healthy can help avoid valuation disputes if/or when a triggering event occurs. There are several methods for determining a fair market value. In most cases, your accountant can be helpful in guiding you through this. It is important to update the valuation of the company on regular basis.
Two: Eliminate Uncertainty
A buy-sell agreement for family business owners makes sense to eliminate the uncertainty. The agreement establishes a guaranteed buyer for your ownership interest should the need arise. In addition, it will protect the remaining owners from the sale of the business to an outside buyer.
Three: Maintain Harmony
A buy-sell agreement for a closely held business provides a roadmap for transferring the business. These remove the uncertainty of how a business will transition. Not having a plan will create a number of conflicts as to how to transition the business at the worst possible time. Oftentimes, it will lead to disputes over the value of the business.
Four: Create Liquidity
If an owner becomes disabled or passes away their family may need liquidity to replace lost income and/or pay estate taxes (if necessary). In situations where a buy-sell agreement does not exist an owner’s estate may have to sell the business to an outside buyer.
In many cases when this happens the family will receive less than fair market value. If there are other owners, it will make it even more difficult to sell the business.
Business Buy Sell Agreement Checklist
How is the business structured?
- Sole Proprietorship
- C Corporation
- S Corporation
- Professional Corporation
- Limited Liability Company
- Limited Partnership
How many owners are there?
What is the percentage of ownership?
How old are the owners?
What triggering events should be covered by the buy-sell agreement?
- Loss of License
- Felony Conviction
How is the value of the business determined?
- Fixed Price
- Book Value
- Capitalization of Earnings
How often will the business value be updated?
- Ever ____ Years
Does the agreement allow for life insurance to cover a buyout at death?
Does the agreement allow for disability insurance to cover a buyout related to a disability?
Final Thoughts – Buy-Sell Agreements for Closely Held and Family Business Owners
A buy-sell agreement is critical for any business regardless of the company’s value. The agreement will serve as an instruction manual for business owners when a triggering event occurs.
It helps owners of a business to deal with the what-ifs before they happen.
- What if you have a triggering event before you are able to sell the business?
- What if you or your partners can no longer operate the business on a daily basis?
- What if you are unable to sell the business?
- Insert you’re what if here…
Once you have your buy-sell agreement in place it is important to review it on a regular basis. Properly funding the agreement will ensure immediate liquidity exists when a triggering event occurs