Buy-Sell Basics

Imagine that you have been in business with your best friend from high school for about 20 years. One day, he sits down in the chair across from your desk and tells you that he is getting a divorce. After expressing your sentiments, he then tells you that he is moving to Las Vegas to become a blackjack dealer. Therefore, he wants to cash out his share of the business and start his new life in Nevada.

What is a Buy-Sell Agreement?

A prudent way to protect the business from such news, is to create a buy-sell agreement as soon as possible. This document lets the business continue operations in the event that something catastrophic happens to an owner, an owner decides to retire or decides to take a job at a casino on the Strip.

The buy-sell agreement immediately defines a buyer’s interest and stipulates the triggers that can prompt a change in ownership. It facilitates continuity of management without involvement from unwanted shareholders or partners. It also ensures that profits need not be shared with unwanted individuals. Determining how the departing owner (or a deceased owner’s family) will be compensated, eliminates unneeded conflict in calculating the value of an owner’s interest or how much management authority a decedent’s loved ones should have as the business continues operations.

Types of Buy-Sell Agreements

There are two basic ways to structure a buy-sell agreement: (i) a cross-purchase agreement; and (ii) an entity purchase agreement. With a cross-purchase agreement, the remaining owner buys the departing owner’s interest directly. With an entity purchase agreement, the business is the buyer of the departing owner’s interest. In addition, there is a “hybrid” approach that combines elements of the first two structures. However, it is less common.

Purchase Price and Valuation

Once the structure is set, the purchase price must be determined. When performing a valuation of a business interest, the value of the assets held by the business, goodwill, depreciation and the accounting method used to conduct business operations should be examined. A third-party professional should be engaged for this task. The valuation will determine the value of the business and apportion that value between the owners, given their relative ownership interests.

Insurance

Another consideration is to guard against an unforeseen event that could cripple the entire business. Therefore, business owners (or the company) should purchase life insurance policies on the life of each co-owner. If one owner dies, the remaining owner (or company) would have the insurance proceeds to pay the surviving family members for the decedent’s interest in the business.

Estate Planning

Finally, buy-sell agreements can be worthwhile estate planning tools for business owners, given the document’s ability to settle most disposition and management issues before they arise.

There are numerous benefits to creating a buy-sell agreement for your business and your loved ones. Think of it as an “estate plan” for the business. However, nothing will happen unless you take action. Procrastination is, after all, the deathbed of good intentions. Do not delay.

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