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Most business owners are concerned with ensuring the sustainability of their business over time. One aspect of business sustainability involves the continuity of business ownership and management in the event one of the owners can no longer continue to work in the business. From this perspective, a business owner will want to think about how to transfer ownership of a business interest from a departing owner and how to fund the buy-out without hurting the liquidity needs of the business. Further, owners also would want their family members compensated reasonably for their ownership interest in a business.

A “buy-sell agreement” is designed to address many of the issues that arise at a time when an owner is no longer involved in the business. A buy-sell agreement is designed to establish a framework for owners to agree on the price, terms and conditions of a future sale of an interest in a business. A properly drafted buy-sell agreement can help ensure long-term business sustainability and provide the departing owner with a ready market for the sale of his or her business interest.

A buy-sell agreement provides for future sales of ownership interests in a business. It outlines the terms for transferring an ownership interest in a business upon the occurrence of certain predestinated triggering events. The most common triggering events include death, disability, retirement, termination of employment, attempted sale of an ownership interest to a third party, divorce and bankruptcy.

Typically, a buy-sell agreement provides that the remaining business owners or the business entity itself will buy the departing owners’ share of the business. In addition to specifying the circumstances that will trigger a mandatory or optional buyout, the buy-sell agreement also will state the price to be paid for the ownership interest, or alternatively, the buy-sell agreement will provide a formula for how that price will be determined.

A buy-sell agreement usually takes one of three general forms: a redemption agreement, a cross-purchase agreement or a hybrid agreement.

In a redemption agreement, the departing owner agrees to sell his or her interest to the business entity itself. The business entity is responsible for financing the purchase, which may be funded by using business capital, loans or insurance on the departing owner’s life.

In a cross-purchase agreement, a departing owner agrees to sell his or her interest to the remaining owners. This format works best in a business with only a few owners. As the number of owners increases, this format can become complicated, especially if the financing of the sell is through life insurance, because it can require multiple owners to have multiple life insurance polices on each of the other owners.

A hybrid agreement is a combination of a redemption agreement and a cross-purchase agreement. Typically, the departing owner must first give the business entity the right to buy the departing owner’s interest. If the entity refuses to buy, then the ownership interest is offered to the remaining owners.

Often a buy-sell agreement is funded with life insurance. Life insurance proceeds can provide cash to buy a departing owner’s interest in a business without jeopardizing the future sustainability of the business.

Implementing a buy-sell agreement can assure business owners that their interest in the business is secured in the event of unexpected future circumstances such as death, disability, retirement, termination of employment, attempted sale of an ownership interest to a third party, divorce or bankruptcy. If your business does not have a buy-sell agreement and this is something you would like to explore, please do not hesitate to contact us.

Bob Merenda, CPA
Partner
Wealth Management Services Group
314.290.3236
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