Why Does Every Business Need a Buy-Sell Agreement?
A Buy-Sell Agreement is a document used by organizations of various types (Sole-Proprietorship, Partnerships, Corporations, etc.) that delineates the exact course of action to follow in case a shareholder/partner/co-owner is incapacitated (disabled), deceased, retired or expressed interest in selling his/her shares of the organization.
Why is it important to have a Buy-Sell Agreement in place?
The Buy-Sell Agreement obliges the sale of a shareholder’s shares based on a predefined formula to the company or the remaining shareholders of the business. Before the interest of a deceased shareholder can be sold to the company or remaining partners, the deceased's estate must agree to sell.
Ideally, Buy-Sell Agreements are fully funded and life insurance is frequently used for this purpose. After determining the value of the business, you, your advisors, and the other parties to the agreement will determine the best way to fund the transaction and the triggers appropriate for your business situation.
The prevailing way of ensuring the availability of funds in the case of a shareholder’s death is by purchasing a life insurance policy on the other shareholders of the company. This allows the proceeds from the life insurance policy to be used to purchase a portion of the deceased shareholder’s interest.
Setting up a Buy-Sell Agreement may involve costs and some possible disadvantages. For example, one disadvantage is that the agreement limits the freedom to sell the business to external entities. However, it is minimal compared to the disadvantages of not having a Buy-Sell Agreement in place. Such situation may create huge litigation issues that will be even more costly to the shareholders and the organization’s well being.
For any advice in setting up a Buy-Sell Agreement, consult with your attorney or financial professional.
Achille Ekeu, MBA, CVA
The Washington Valuation Group
Achille is a Certified Valuation Analyst and Member of the National Association of Certified Valuators and Analysts (NACVA) in the DC-MD Chapter. He provides valuation services for Estate and Gift Tax, Buy Sale, Debt Financing, Buy-Sell Agreements and Litigation Support in Divorce cases. He can be contacted by phone at 240-274-9570 or by email at firstname.lastname@example.org.