A buy-sell agreement between shareholders or between the shareholders and the business entity is an important business succession planning tool. A buy-sell agreement is an agreement that lays out how ownership shares (or interests) will be transferred in the event an owner dies, becomes disabled or wants to sell or transfer his or her shares. By providing an orderly mechanism and a timeline for ownership transfer, the agreement gives stability to the business during a time of potential uncertainty. It enables management to reassure business creditors and key business partners of the continuation of the business. It provides liquidity to fund testamentary dispositions (estate plans involving gifts and trusts).
Essential deal points of a buy-sell agreement:
- A restriction on transfer of ownership interests. There is no sale or transfer of shares except under the buy-sell mechanism.
- An agreed mechanism for valuing the shares (preagreed price, business appraisal, or some combination of both).
- Triggering events: death, disability, bankruptcy, withdrawal/retirement, termination of employment
- Time frame for completing the sale
- Payment of purchase price
- Includes the community property interest of non-employee spouses (the non-employee spouse must sign)
Variable deal points of buy-sell agreement
- Mandatory purchase or right of first refusal
- Non-competition agreement
- Purchase by the business (redemption agreement) or by other owners (cross-purchase agreement).
Funding a buy-sell purchase on the death of a owner:
- As part of the planning process, the company in advance purchases and maintains life insurance on the life of each partner; the premium is a deductible business expense. (“Key employee” insurance)
- The insurance death benefit is paid to the company,.
- Alternatively: the policy is owned by the other shareholders and the death benefit is paid to the purchasing partner.
“Shot-gun clauses” can be added to allow 50/50 partners to exit the business relatively quickly and equitably.
Primuth & Driskell, LLP recommends that all business owners have a buy-sell agreement in place for their family business as part of their estate planning. Call our office today for an evaluation of your current business succession strategy or to learn how business succession applies to your business.