Buy-Sell Agreements:
One of the Most Important Estate Planning Documents for Business Owners
For many entrepreneurs, their business is their largest asset. Yet surprisingly few business owners have a written plan addressing what happens to that business when an owner dies, becomes disabled, retires, divorces, or simply wants to leave.
Without a properly drafted Buy-Sell Agreement, the future of the business—and the financial security of the owner's family—may be left to chance.
A Buy-Sell Agreement is one of the most valuable planning tools available for business owners because it protects the business, the remaining owners, and the departing owner's family.
What Is a Buy-Sell Agreement?
A Buy-Sell Agreement is a legally binding contract that establishes what will happen to an owner's interest when certain "triggering events" occur.
Rather than leaving ownership transfers to negotiation after a crisis, the agreement creates a roadmap that everyone has already agreed upon.
A well-drafted Buy-Sell Agreement answers important questions before they become expensive disputes.
Why Every Business Owner Needs One
Imagine that your business partner unexpectedly dies.
Without a Buy-Sell Agreement:
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your partner's ownership interest may pass to a spouse or children who have no experience running the business;
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the surviving owners may suddenly find themselves in business with family members;
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disagreements over the value of the business can lead to litigation;
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the business may lack the cash needed to purchase the deceased owner's interest; and
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years of hard work can quickly become entangled in probate proceedings.
A properly drafted Buy-Sell Agreement helps avoid these problems by establishing clear rules long before they are needed.
Common Triggering Events
A Buy-Sell Agreement typically addresses what happens when:
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an owner dies;
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an owner becomes disabled;
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an owner retires;
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an owner voluntarily leaves the business;
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an owner files for bankruptcy;
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an owner divorces;
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an ownerloses a required professional license;
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an owner becomes subject to a charging order or other creditor issues; or
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an owner commits certain acts that justify removal from ownership.
By planning for these events in advance, business owners reduce uncertainty and protect the continuity of the business.
What Should a Buy-Sell Agreement Include?
Every business is unique, but most Buy-Sell Agreements address:
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who has the right—or obligation—to purchase the departing owner's interest;
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how the purchase price will be determined;
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when the purchase must occur;
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how the purchase will be funded;
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whether payments may be made over time;
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restrictions on transferring ownership interests;
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non-compete and confidentiality provisions when appropriate; and
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procedures for resolving valuation disputes.
These provisions help eliminate uncertainty during emotionally and financially stressful situations.
How Is the Purchase Funded?
A Buy-Sell Agreement is only as effective as its funding.
Common funding methods include:
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Life Insurance
Many businesses purchase life insurance on each owner. If an owner dies, the insurance proceeds provide the funds needed to purchase the deceased owner's interest without placing financial strain on the business.
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Installment Payments
In some situations, the purchase price is paid over time pursuant to a promissory note.
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Company Funds
The business itself may accumulate reserves to fund future buyouts.
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Hybrid Funding
Many agreements combine life insurance, business reserves, and installment payments depending upon the circumstances.
Choosing the appropriate funding method depends upon the value of the business, the ages of the owners, and the financial resources available.
Cross-Purchase vs. Entity Purchase Agreements
Buy-Sell Agreements generally fall into two categories.
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Cross-Purchase Agreement
Each owner agrees to purchase the ownership interest of a departing owner.
This approach is often appropriate for businesses with a small number of owners.
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Entity Purchase (Redemption) Agreement
The business itself agrees to purchase the departing owner's interest.
This approach may be easier to administer when there are multiple owners.
Selecting the proper structure requires careful legal and tax planning.
Coordinating Your Buy-Sell Agreement with Your Estate Plan
A Buy-Sell Agreement should never be drafted in isolation.
It should coordinate with your:
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Revocable Living Trust;
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Last Will and Testament;
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Durable Power of Attorney;
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succession planning documents;
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Operating Agreement or Shareholders' Agreement; and
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life insurance planning.
Without proper coordination, conflicting provisions can create unnecessary confusion and litigation.
Advantages of a Buy-Sell Agreement
A properly drafted Buy-Sell Agreement may:
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provide liquidity to a deceased owner's family;
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preserve continuity of the business;
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keep ownership within the intended group of owners;
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establish a fair method for valuing the business;
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reduce the likelihood of litigation;
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facilitate business succession planning;
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coordinate with the owner's estate plan; and
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protect the value of the business for future generations.
Is a Buy-Sell Agreement Right for Your Business?
If you own a business with one or more partners, the answer is almost certainly yes.
Whether your business is organized as a corporation, limited liability company, partnership, or family business, a Buy-Sell Agreement provides certainty during life's most unpredictable events.
Your business may represent decades of hard work and one of your family's largest financial assets. Taking the time to establish a comprehensive Buy-Sell Agreement today can protect your business, your family, and your fellow owners for years to come.
Like every sophisticated estate planning tool, a Buy-Sell Agreement should be carefully tailored to your business structure, tax objectives, and long-term succession goals.