When focusing on the day-to-day needs of your business, it is easy to forget to plan for what will happen when you are no longer around. A buy-sell agreement acts like a Will for a business and allows for the continuing Partners to keep operating the business while ensuring that the beneficiaries of the outgoing Partner will receive a cash amount representing their market value share of the business.
A Buy-Sell agreement is essentially an agreement between Partners that grants an outgoing Partner the ability to sell their respective interest to a continuing Partner in the event that they choose to leave the business, or alternatively, an option for a continuing Partner to purchase the outgoing Partner’s interest in the business upon the occurrence of specified events, such as death or incapacity. A Buy-Sell agreement can also be set in place for sole proprietors if they have a trusted employee who they would like to take over once they are no longer around.
Why is it important?
It’s impossible to anticipate when a serious accident or illness will strike, but setting in place a Buy-Sell agreement will leave your business prepared in the event of a disaster. In situations like this, there are a number of difficulties that may arise. Firstly, there is often insufficient capital for the remaining business partners to buy out the outgoing Partner. Secondly, the business may continue to operate under the remaining Partners, but the family of the outgoing Partner will continue to reap the benefits of their hard work. Finally, a family member of the outgoing Partner may step into their shoes without the skills to do so, which may have adverse consequences on the financial sustainability of the business.
How does it work?
Often the Buy-Sell agreement, in the event of death or incapacity, will be funded by the proceeds of a life insurance policy which provides for the outgoing Partner or their estate to be paid the equivalent amount of their interest in the business. Any difference in the market valuation will be paid by the continuing Partners by way of documented terms within the agreement. This usually includes a vendor finance arrangement, meaning the continuing Partners will pay money to the outgoing Partner or their estate in regular instalments over a specified period.
For businesses carried on by companies, there are two forms of agreement which may be put into place. A Cross-Purchase agreement, similar to a Buy-Sell agreement, allows the continuing Partners to purchase the shares of the departing Partner. A redemption agreement, on the other hand, is where the company itself will purchase back and cancel the shares of the departing Partner. Where the proceeds of the life insurance policy are insufficient to meet the full purchase price, a hybrid agreement may be entered into where the company purchases and cancels any remaining shares not purchased by the continuing Partner.
Agreements like these often consider situations such as death, total and permanent disability, and trauma, but they can also include the bankruptcy or retirement of a Partner or a breakdown in the relationship between Partners. They often include provisions determining how both the business and the outgoing Partner’s share should be valued, as well as dispute resolution provisions to ensure that any potential conflicts are handled in the most appropriate way.
A Buy-Sell agreement’s main purpose is to provide certainty to business owners in the event of a disaster. It often includes a life insurance policy and a vendor finance arrangement to fund the purchase of the outgoing Partner’s share in the business at market value price.
If you require further information about how a Buy-Sell agreement can benefit you and your business, speak to a lawyer at Preston Law today.