Owning a business can be an exciting, potentially lucrative venture; one where you are your own boss and are in a position to make key decisions that will impact the success of the company. Whether you are the sole owner or you co-own a company with one or more individuals, it is highly recommended that you consider a buy-sell agreement in order to protect the future sale of your business interests or for your purchase of a co-owner’s interest in the business.
You do not have to own a large corporation to make securing a buy-sell agreement a wise business decision. Also known as a buyout agreement, a buy-sell agreement protects business owners when a co-owner wants to leave the company or if a co-owner retires, wants to sell his or her shares to someone else, goes through a divorce, becomes disabled or dies. Similar to a premarital agreement, a buy-sell agreement protects everyone’s interests from the moment the business is established.
When considering the cost of a buy-sell agreement, keep in mind that this type of agreement can prevent ill will among family members, co-owners and spouses by establishing a clear, agreed upon financial agreement. It is not unusual for liquidity issues to arise over the course of a major financial business transaction. The investment is small considering the financial benefits in the long run.
Factors to Consider
Like any major financial decision, there are a wide range of factors to consider before entering into a buy-sell agreement, including the following:
- Type of business, i.e., C corporation, S corporation, LLC or other
- Size of the business, including volume of business, number of employees, assets, etc.
- Value, book value or liquidation value of underlying assets
- Percentage of ownership interests of the owners
- Ages and health of equity owners
- Ability of the owners to obtain life insurance in adequate amounts and at acceptable premiums
- Owners’ commitment to the business
- Legal issues that could impact the corporation’s ability to make dividend distributions
- Family relationships of owners
- Likelihood of current owners remaining active in the business and how future generations will participate in the business
- Licensing and other legal requirements
Buy-sell agreements are often funded by life and/or disability insurance policies. Once the value of the business is determined, the parties involved will decide the best way to fund the transaction. Using insurance in this way can ensure that there is money available when it is needed. For example, if you or your partner dies, your respective life insurance policies can fund the buyout so that your business remains in tact, and spouses and or other heirs are bought out based on the agreement.
If a co-owner wants to buy back another co-owner’s interest, there are options available that can be written into the contract. Even the most successful business may not be able to afford a 100% lump sum payout, so a buyout agreement can specify a down payment of one-fourth to one-third of the buyout price, followed by equal installments over the course of three to five years at a reasonable rate of interest.