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Planning for the Buy Sell Agreement

06.01.10  |  By Deborah S. Barcham

Along with death and taxes, the only other certainty in life is that every closely-held business needs a buy-sell agreement. The corollary to this rule is that regardless of whether a business is organized as a corporation, partnership or limited liability company, a buy-sell agreement should be in place to address specific events that, if they occur, will undoubtedly have a dramatic impact on the business owners as well as the future of the business itself.

Unlike a publicly traded company where the “owners” usually exercise no management or control of the business or develop personal relationships with each other, members of a closely-held company have specifically selected each other as business partners, maintain a close working relationship and are active participants in the operation of the business. Also, unlike a publicly traded company, the closely-held company does not have a public market for the sale of an owner’s interest.

The owners of a closely owned business must plan in advance for the sale or disposition of his or her ownership interest. If the business of the company is to provide licensed professional services such as architecture, engineering or medicine, the market for the sale of an owner’s interest shrinks even more.

For the business owner who is contemplating retirement or who becomes disabled, the looming issue becomes, “how will I get my equity out of the business?” If the business owner dies, the issue becomes what happens to the deceased owner’s interest in the business? A related question is how can the remaining owners control the business ownership and avoid becoming “partners” with the deceased owner’s spouse or children? In all those instances, valuation of the company and obtaining the money to purchase an owner’s interest becomes a paramount issue for all concerned.

Rather than wait to address these issues when upheaval occurs, a buy-sell agreement is a planning tool that can be utilized to accomplish the following goals:

  • ensuring conformity of management and control while creating a market for the shares of a deceased, retiring, disabled or withdrawing owner;
  • determining who will take over as owner, so that in the event of death, retirement, disability or withdrawal, the remaining owners do not suddenly find themselves in business with the spouse or children of the departed owner;
  • addressing how to handle disputes regarding growth, salaries or other business decisions
  • preventing the continued involvement in the business of retired or inactive owners;
  • establishing the value of an owner’s interest;
  • continuing the legal existence of the business after the death, retirement, withdrawal, bankruptcy or expulsion of an owner.

The buy-sell agreement is the Rule Book for the closely-held business. It becomes activated when an owner wants to sell his or her interest, and it usually provides that the business has the right of first refusal on the same terms as a third-party offer. In many cases, the buy-sell agreement would provide that in the event of the death of an owner, the business or the remaining owners would be required to purchase the deceased owner’s interest at a predetermined price and typically with life insurance purchased specifically for that purpose.

The buy-sell agreement also addresses specific retirement and disability situations, and contains a buy-out valuation formula. For professional businesses, the loss of a professional license prevents the practice of the profession by that owner and triggers a mandatory buy-out. The terms and conditions of a buy-out agreement are negotiated in advance of any problem arising. Moreover, the parties may change the terms as they may agree.

Smart business planners address these issues when everyone is in the “honeymoon” stage, not when the business is in crisis. Regardless of whether you may wish to sell your interest or to purchase the interest of a retiring, disabled or deceased partner, waiting until a problem arises may be far too late.

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