While you’re in the midst of planning, growing or expanding your business, it’s important to develop and execute a buy-sell agreement between all business owners. A buy-sell agreement can provide structure for an unexpected event such as a death or disability, and provide a road map for expected events such as a shareholder retirement buy-out. Setting up a buy-sell agreement in the early stages of your business planning can help you handle the unexpected and expected events more swiftly in the future – and with a lot less stress.
What is a buy-sell agreement?
A buy-sell agreement essentially outlines the exit strategy for owners to avoid confusion and/or disputes down the road. It also can establish the process and buy-out funding for an owner’s spouse or estate in the event of a tragedy, and avoid the potential problem with an owner’s family members getting unwanted ownership in the company. As a result, the buy-sell agreement and related insurance policies can ensure that they get a payout from the business without having to get involved in its day-to-day operations. Simply put, every business with more than one owner should have a buy-sell agreement in place.
How do I choose the right buy-sell agreement for my business?
There are two common forms of agreements: a cross-purchase agreement and a redemption agreement:
- A cross-purchase agreement allows the company’s other shareholders to purchase the shares of the departing owner. It is essentially a pre-determined buy-out arrangement with each owner having an insurance policy that would fund the buy-out if a tragic event occurs.
- An ownership redemption agreement requires the company to purchase the departing owner’s stock instead of the remaining partners. This arrangement also involves insurance policies to fund the company’s buy out if necessary.
You are able to combine elements of both the cross-purchase agreement and the redemption agreement to create a more customized buy-sell agreement. The decision is really up to the business owners and how they’d like to structure their buy-sell agreement.
How do I set up a buy-sell agreement?
Setting up a buy-sell agreement is an investment in your business’ future. Your buy-sell agreement should be unique to your business and the owners’ goals. As you sit down as a team to develop and draft and your buy-sell agreement, with the involvement of your attorney and CPA, here are a few reminders:
- Set up the buy-sell agreement as early as possible. It is recommended that all owners come to an agreement before business begins. If you already have a business with more than one owner and don’t have a buy-sell agreement in place, establish one as soon as possible.
- Discuss and develop the details of the agreement. This includes laying out the “triggering” events, which are often referenced as the 4 Ds – death, disability, departure and discord. This also includes addressing questions related to buy-out prices or values. For example, if an owner departs the business as a result of an unlawful or deceitful act, or after a dispute (i.e. discord), will there be a reduction in the buy-out price as a “penalty” for their actions or leaving the business in turmoil?
- Put in place the life and/or disability insurance policies and enlist the help of trusted professionals. The policies are to ensure that the company or owners have the buy-out funding when a triggering event occurs. It is highly recommended to have an attorney draft the document and then have CPAs and business valuation professionals develop the details of the agreement before finalization.
- Write a valuation clause and note how the business will determine ownership value. This planning can involve an initial value and annual updated amounts, or a valuation formula or method agreed upon by owners with the help of a valuation expert.
Corrigan Krause Can Help
The Corrigan Krause team is here to help. Our team of experts has extensive experience working with businesses at all stages. Feel free to reach out to your Corrigan Krause team members or email info@corrigankrause.com.
