An Introduction to Buy-Sell Agreements

by | Small Business Consulting

You might think your business partner’s spouse is terrific. You appreciate the support of the long hours and the understanding of the many sacrifices that must be made to grow a business. You get along fine during social situations. You even send a nice gift for the holidays. Heck, it’s like an extended family.

But if your partner becomes incapacitated, dies, or is otherwise forced to leave the business, would you want to be in business with the spouse? That’s a million-dollar question.

An Ounce of Prevention

Sorry to be the bearer of bad news, but unless you’re incredibly lucky, it’s very likely that however lucrative and enjoyable your partnership may be, it will come to an end at some point. Consider the case of a fairly successful services company. Assume it’s an established, “going concern” and a viable business. If one partner dies, what happens in terms of transfer of ownership to the late partner’s spouse or other heirs?

Assuming you don’t want the spouse involved in the business, you would have to buy-out your partner’s interest in the company. But at what price? Under what terms? And with what funding? Maybe your partner’s spouse seems reasonable, kind and accommodating in everyday circumstances, but as you’ve probably noticed, people tend to get a little, uh…self-serving when it comes to money matters.

This is where a buy-sell agreement can help. A buy-sell agreement can prevent confusion, disputes and fighting between co-owners, spouses and family members. It can also provide you with enough liquidity to keep the business running while matters are sorted out after the death of your partner, and help you deal with possible financial, tax, logistical and operating problems.

Buy-Sell Agreements

A buy-sell agreement is an arrangement between the owners of a business. It dictates what happens if one of the owners dies, or leaves the business for other reasons. Buy-sell agreements are legally binding and are very common for businesses of all sizes.

A buy-sell agreement typically dictates what happens pertaining to these matters:

  • What triggers the buy-out. The death of an owner is what is usually assumed to initiate a partner’s option to buy another’s stake in the company. But retirement, disability, divorce, or even professional burnout are commonly cited.
  • Who can buy the former partner’s share of the company. For our purposes, we assume the remaining partner or partners will purchase. But it’s possible to name other eligible buyers in the agreement.
  • The price to be paid for the former partner’s ownership. The price might be pre-determined or fixed, or arrived at by some previously agreed upon appraisal method. The agreement will also note whether the purchase is to be made with one payment, or in installments.

Two Types of Agreements and How to Pay for Them

Two very common kinds of buy-sell agreements are the Cross Purchase Agreement and the Redemption Agreement.

In a Cross Purchase Agreement, there is direct reciprocity – that is, if your partner dies, you get to buy his shares. If you die, he gets to buy yours. In a Redemption Agreement, the company itself buys the former partner’s ownership stake.

In situations where the death of a partner has brought about the buy option, an insurance policy can make sure the funds are available to complete the transaction. Policy proceeds make it possible to keep the business running and pay the late partner’s spouse as previously agreed. To make sure this works, adequate policies must be underwritten on the life of each partner in the arrangement.

Get Professional Help

You’ve probably already guessed that putting together a buy-sell agreement that will meet your needs will require the assistance of a lawyer experienced in these types of arrangements. You should also have a qualified financial advisor and/or life insurance professional involved in the process.

And by the way, no one knows for sure which partner may have to leave the business first due to death, injury, divorce, etc. For that reason alone, buy-sell agreement negotiations usually don’t have a hard-edge to them. Coming to agreement on most of the issues regarding the transfer of ownership is relatively easy.

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For more specifics about invoice factoring, visit MP Star Financial online or schedule time to talk with a representative. Don’t wait 30 to 45 days for payment. MP Star can get funds to your account faster. Call MP Star Financial today at (877) 292-1904, extension 150.