The 1st in a 3 part series, this article will introduce you to buy-and-sell agreements and why you would need one. Keep an eye out for the following articles where we will go into more detail and share a practical example or two.
A buy-and-sell agreement is used for buying and selling businesses, right?
No. Despite the name, buy-and-sell agreements have very little to do with buying and selling businesses. Instead, they are binding contracts between co-owners that control when owners can sell their interest, who can buy an owner’s interest, and what price will be paid. These agreements come into play when an owner retires, goes bankrupt, becomes disabled, divorces, or dies – in other words, this agreement is a sort of prenuptial agreement between business co-owners. Mainly these agreements guide buyouts between the owners themselves – hence the popular referral to such agreements as buyout agreements.
When does a business need a buy-sell agreement?
Every co-owned business needs a buy-sell, or buyout, agreement the moment the business is formed or as soon after that as possible. A buy-sell, or buyout, agreement, protects business owners when a co-owner wants to leave the company (and protects the owner that is leaving). If a co-owner wants out of the business, wants to retire, wants to sell his shares to someone else, goes through a divorce, or passes away, a buyout agreement acts as a sort of “premarital agreement” to protect everyone’s interest, setting the price and terms for a buyout. Every day that value is added to a business without a plan for future transition, it increases the owner’s financial risk.
The “how” of buy-and-sell agreements…
One of the best ways to facilitate the buying and selling of a deceased partner’s interest in a business is through the use of a whole life insurance policy. In the case of two business partners, they both take out life insurance policies on each other’s lives.
Typical clauses you will find in such an agreement are:
- An obligation on the surviving shareholder/s to purchase a shareholding on the death of a shareholder.
- An obligation on the executor of a deceased estate to sell the shareholding the deceased had in a business.
- An explanation of the buy-and-sell is to be funded, i.e. from the proceeds of a life insurance policy
- An indication of how the purchase price is to be determined
- An obligation on surviving shareholders to purchase the life policy which a deceased shareholder had on their (the surviving shareholders) lives.
- Under what circumstances the agreement may be terminated and how, and what are the consequences thereof.
- How disputes are to be resolved.
In next week’s issue, we’ll look at some practical examples of how these agreements and policies are physically implemented.
If you do not have this critical part of your business’s risk management strategy covered, do not waste any time. Contact our office today for a no-obligation consultation to assess your requirements.