Buy-Sell Agreements

Posted: July 31st, 2009 | Author: | Filed under: Small Business Topics | 1 Comment »

“Do we need a Buy-Sell agreement?”.  The fact that clients ask this question is a great sign; it shows that they are at least aware of the fact that where there are two or more owners of a business or legal entity, they should always have a plan that describes clearly what will happen if something happens to one of them, or if he or she wants out of the relationship.  

This plan is often called a “Buy-Sell” agreement, and I can honestly say that it can be one of the most difficult and demanding documents to put together, but also one of the most essential.  

Now I’m the first to agree that there are many form documents available to consumers these days that require little input beyond a basic set of Q&A prompts (such as simple wills or real estate documents), but I would not place buy-sell agreements in this category.

The reason these documents are tricky is that you have a host of interlocking variables to think through (I imagine it would be a bit like writing computer code – if this, then that, and so on).  For example, let’s say you have two business owners who both are actively involved in running the business.  There are a host of different circumstances that could result in one of the owners leaving the business, and which the owners should at least be aware of.  These include death, disability (you can’t work), divorce (a non-working spouse is awarded the business), bankruptcy, retirement, voluntary sale, forced sale by creditors, and resignation as an employee.

Once the owners have identified the circumstances that they believe may apply to them, they need to think about how to deal with the departing owner’s interest in the business in each of the circumstances they have identified.  Again, they are a number of variables to choose from.  For example, if an owner were to die, the business could either be forced to buy the interest from the deceased owners’ estate, which would put cash into the estate for the benefit of the deceased owner’s heirs, or have the option to do so.  Allowing the spouse of a deceased owner to become an owner where he or she may have little experience in running the business may prove to be disastrous, so the owners need to think this through carefully.  The same type of decision would need to be made for each of the other circumstances I mentioned above.

Once the owners have decided how to handle the different circumstances, they would need to figure out how to value the interest of a departing owner if he or she will be bought out, and how to pay for it.  In the case of death, life insurance is most often used to fund a buyout, but in other circumstances, the owners may wish to pay a departing owner over a number of years to protect the business’ cash flow.  Where a departing owner is to be paid over time, he or she may want some collateral to insure timely payment.

Finally, buy-sell agreements should form an integral part of any family succession plan where families may be contemplating transferring a business to the next generation.  Although the context here may be a little different, the basic issues are pretty similar. 

I have really only touched on the basic issues in this post, but as you can see, it can be pretty tricky to get this document to read simply and clearly, and yet still cover the basics.  I strongly urge all business owners to make sure that they have a buy-sell type agreement that they understand, and if they don’t, they should seek professional input.  

One Comment on “Buy-Sell Agreements”

  1. 1 Derek Johnson said at 10:59 pm on September 3rd, 2009:

    Great blog post Simon, every entrepreneur starting a company should read this one! Keep up the good work.

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