Buy-Sell Agreements: A Business Owners Biggest Neglect

Small businesses in America have played a substantial role for the economy when it comes to an improved job market. Surprisingly enough, small businesses are responsible for nearly sixty-percent (60%) of the jobs in the country. Undoubtedly, they are the driving force for a healthy economy. So what is to happen when a small business owner suddenly dies or becomes disabled; what strategies have business owners implemented to help withstand such tragic events?

Succession planning is one of the most overlooked aspects of a business, where business owners are much too focused on running their business, and forget to strategize on the succession of their business. Put simply, a succession plan is an exit strategy for the owner, where the owner ensures their business will go through a smooth change of ownership in the event of the owner’s death, disability or retirement.

Although a plan is not necessarily designed for every owner, it is valuable to those who look to monetize their investment and find the importance of having continuity of their business. Regardless of the stage of the business, whether the beginning or the end, developing a succession plan is vital for its continued success and growth.

All owners, whether full or partial, should know about one of the most important documents associated with succession planning: Buy-Sell Agreements. Unless an owner feels they are immune to death or disability, or believe they will never retire, not having a Buy-Sell Agreement can be the cause of severe financial and tax problems. Take the following example:

Mike and Joe run a construction business as 50/50 partners, with no written partnership agreement, simply a handshake.  Joe dies.  Does Mike still have a business?  Is Joe’s wife or child Mike’s new partner?  Does Mike have the right or the obligation to buy them out? If so, for how much and under what terms? How will Mike pay for Joe’s percentage interest?

This is where the value of a Buy-Sell Agreement is shown.

What is a Buy-Sell Agreement?
It is a legally binding document between owners of a business that establishes guidelines for when a co-owner dies, becomes disabled, or chooses to retire.

When is the right time to have a Buy-Sell Agreement in place?
Any business with multiple partners should have a Buy-Sell Agreement in place. With the uncertainty of death or disability, understanding the terms that govern such triggering events can help the remaining business owners go through the process of selling the deceased/disabled individual’s ownership interest. When a co-owner wants to retire, sell their shares, get divorced or simply die, the Buy-Sell Agreement serves to protect everyone's interests, by having a predetermined formula on establishing the value of the selling owner’s share.

What is the cost-benefit in having one prepared?

The cost of a buy-sell is minute compared to the benefits associated with it. By establishing an agreement and keeping it updated, it can help avoid disputes between family members, co-owners and spouses. It helps keep the business alive and ensures the reputation of the business survives by avoiding having the business dissolve/liquidate due to infighting amongst family members or spouses.

Disputes and confusion over the business often result after one co-owner decides to leave or dies. The stakes are even higher depending on the size of the business itself. Implementing a buy-sell further helps avoid a co-owner being able to sell their interest to a competitor, as the agreement could outline such restrictions.

Do I need to be in a specific type of business and/or industry?
No. A Buy-Sell Agreement is relevant for any business owner, operating any business, in any industry, under any structure. The more owners involved in the business, the larger the role of the document.

 

How does insurance tie into all this?
Insurance plays a large role in Buy-Sell Agreements. Although they don’t need to be used, it can provide comfort in knowing there is cash available when the time comes. Using the above example, if Mike or Joe die, and it was agreed between the two that the survivor will buy-out the other’s interest, a life insurance policy on each owner can secure the buyout, thus mitigating the need of funds.

Who can help?
With any sound Buy-Sell Agreement, an owner needs an equally sound business attorney. Paying an attorney to discuss the goals and strategies of the business, to help draft a concise and clear succession plan should be seen as an investment rather than an expense. If the purpose of a business is to continue beyond the life of the original owners, then investing the time to meet with professionals should become a top priority.

Adil Daudi is an Attorney at JKY Legal Group, P.C., focusing primarily on Business law, Succession Planning, Contract Drafting and Health Care Law. He can be contacted for any questions related to this article or other areas of law at adil@jkylegal.com or (517) 381-2663.