Buy-sell agreements: What every business owner should know

864 Views

By Rob DeHollander

Rob DeHollander
Rob DeHollander is managing partner and co-founder of the DeHollander & Janse Financial Group.

As a business owner, I know how easy it is to get stuck working “in your business” rather than “on your business.”

However, I recently saw the cost of this in a tragic light, and it’s a cautionary tale. I worked with the family of a business owner who ran a very successful business in the Upstate for more than 20 years. Unfortunately, he had done no business planning, and a critical oversight was the absence of an exit strategy. When he died unexpectedly, it cost the family about 30% of the fair market value of the business. Imagine if you invested years of hard work and then your family had to sell your business at deep discount.

Every business owner should have a plan in place to ensure the continuity of the business should anything happen to them. For many business owners, this plan involves setting up a buy-sell agreement.

What is a buy-sell agreement?

A buy-sell agreement ensures business continuity if the owner becomes disabled, decides to retire, or passes away unexpectedly. It outlines the parties involved in the agreement, describes the events that trigger a transfer, and lays out an agreed-upon value of the business. Having this kind of agreement in place can help avoid rushed decisions during what can be a stressful time.

Structuring the agreement

There are several ways to construct a buy-sell agreement. The best choice for you will depend on your company’s structure and ownership:

  • Cross purchase: Another business partner agrees to purchase the business from the owner or the owner’s family.
  • Entity purchase: The business entity agrees to purchase the business from the owner or the owner’s family.
  • Wait-and-see: The buyer of the business is allowed to remain unspecified, and a plan is put in place to decide on a buyer at the time of a triggering event (e.g., retirement, disability, death).

Funding methods

It’s important to include funding details in a buy-sell agreement to ensure a successful transfer and to keep the business running smoothly. Common funding methods include cash or assets of the business, a loan, and installment payments, as well as employee stock ownership plans (ESOPs) and insurance.

ESOPs

When selling a business to employees, an ESOP can be established to help provide a source of funds. An ESOP requires specialized administration to navigate the complexity of the agreement and to comply with the applicable rules and regulations. Candidates for an ESOP generally fit within the following guidelines:

  • Privately held, profitable C or S corporation
  • More than 30 employees
  • Value of at least $3 million
  • Established management team and strong cash flow history

Life and disability insurance

Insurance provides liquidity to help the business during a challenging situation or to purchase the business from a grieving family. Depending on the structure of the company and the type of buy-sell agreement, the business may be able to pay the premium, or bonuses may be given to those policy owners who pay the premiums.

• In a cross-purchase agreement, all business owners will purchase, own, and be the beneficiary of an insurance policy insuring each of the other business owners.

• With an entity purchase agreement, the insurance policy is usually owned by the business. Even with multiple owners, only one policy per owner is needed.

• In wait-and-see agreements, the policy ownership and beneficiary structures vary, depending on the type of the agreement that is ultimately put in place.

Next steps

When determining whether a buy-sell agreement would work for your business, keep these considerations in mind to help you make the best choices for your company, your partners, and your employees. If you do move forward with a buy-sell agreement, be sure to consult with an attorney and a tax adviser to develop a plan that best serves the needs of your business.


Robert DeHollander, a certified financial planner, is a managing partner and co-founder of the DeHollander & Janse Financial Group in Greenville. Find out more: www.djfinancial.com

SHARE

Related Articles