If you are thinking about starting a business with a partner or have established a successful business and don’t have a plan for what happens next, then consider succession planning for your business with a buy-sell agreement. A buy-sell agreement is one way to provide an orderly plan to transfer of ownership of your business with terms that you have negotiated ahead of time. Clearly defining exit strategies can help you to avoid complications that go against your interests.
With a quality Buy-Sell Agreement, you can protect the value of your ownership interest and prevent the business from being picked apart by competitors, legal battles between your family and business partners, or your business evaporating into thin air.
Your agreement should include detailed information about your business’ worth. It is important for these numbers to be as accurate as possible. Because your company’s value may not remain the same, you should consider having it professionally appraised or using a clearly defined formula to value the business. Business appraisals of your company can be expensive, so you need to consider what works best for your business and the parties involved. You want the valuation provision clearly defined to establish a fair purchase price in order to reduce suspicion and conflicts of interests.
Funding the Buy-Sell
You want to make sure the Buyer has the financial ability to fulfill the payment terms of the agreement. In addition to a cash sale, other funding options for Buy-sell agreements often include life insurance policies or installment payments over a period of time. Don’t just assume the Buyer will have the cash at the time to purchase the business or that they can borrow 100% of the purchase price. There are pros and cons of each option and this is an essential conversation to have for any buy-sell agreement.
Identity the Parties
To have a valid buy-sell contract, you need an agreement from at least two parties. There must be a Buyer and a Seller. This may seem obvious but choosing who you sell your business to requires careful consideration and often times the consent of other partners in the business. Depending on the type of business, there also may be legal obstacles and licensing requirements to consider.
Identify Qualifying Events
Arrange a meeting with your partners or outside buyer to discuss the events that will trigger a buyout. You should try to anticipate any life events that can interfere with the partnership, such as death, divorce, illness and retirement. Do not overlook breach of contract and obligations. The goal is for you to cover all bases so you can better protect your interests should a buyout occur. In certain events like the death of a partner, you want to make sure the buy-sell agreement coordinates with the deceased partners estate plan to avoid getting caught in the middle of a dispute among the deceased partner’s heirs.
It is important for you to understand that proceeds from buying and selling ownership in businesses can be taxable. You may want to also work with your CPA so you can structure your agreement to minimize tax liability. If you do not, you could end up having a higher tax liability than expected that will offset your profits from the proceeds.
This is Only the Tip of the Iceberg…
Bear in mind that there are many other things you should take into consideration when creating a buy-sell contract. However, the time and efforts you contribute now to the process can help to ensure the health and longevity of your business and that you and your family receive the maximum benefit from your years of hard work.