Why Business Partners must have a Buy & Sell Agreement

A Buy & Sell Agreement is a vital ingredient to a business that has more than one owner. This agreement is also known as a Buyout Agreement.

A Buy & Sell Agreement is a legally binding contract that, in the event that one of the business owners is unable to continue to operate the business with the other owners, governs how a business owners’ exit out of the business will be dealt with and how the ownership interest will be transferred or treated.

Situations where there may be a need to replace a business partner or acquire his share by the other partners includes events such as the death of a partner, long term illness, permanent disability, retirement, divorce, and bankruptcy.

Although the best time to put one in place is at the very beginning of the business venture, if you share ownership of a business with at least one other individual and do not have a Buy & Sell Agreement in place, then you should act to do so immediately. Don’t wait until a life changing event occurs.

Why should every multi-owner business have one?

A Buy & Sell Agreement will ensure that all parties involved in the business are protected and not disadvantaged.

For the outgoing co-owner, and his family, some of the advantages of having a Buy & Sell Agreement include:

• The outgoing owner, or their Estate, receives an agreed or fair market price for their interest in the business and it is secured

• Avoidance of a ‘forced sale’ which sometimes will not provide the outgoing owner, or their family, with the best financial outcome

• In the event of death or permanent disability, the family of the outgoing owner do not have the burden of having to be involved in the business or having to make business decisions during a stressful time or being too inexperienced to do so.

For the remaining business owners, the Agreement will:

• Ensure a smooth transition to the continuing owners in relation to the control and ownership of the business

• The remaining owners will not be required to continually support the family of the outgoing owner, especially in the event of death or permanent disability, as the Agreement will provide for the family

• The assets and liquidity of the business will not be jeopardised or challenged

• The business continues with minimal disruption

• The future of the business, its’ existing owners and their positions, will be clearly defined.

A well-documented and carefully thought out Buy & Sell Agreement will also ensure that all owners, continuing and exiting, do not incur adverse legal or tax implications which could arise when the Agreement becomes effective.

A Buy & Sell Agreement will also take precedence over an owners’ personal will, in the event of death, and the business ownership will be transferred pursuant to the Agreement. Which is why the Buy & Sell Agreement is sometimes called a “business will”.

What should the Agreement contain?

First, and foremost, there should be a “Funding Agreement” to go hand in hand with the Buy & Sell Agreement. But more about this later.

All Buy & Sell Agreements should consist of several legally binding clauses to determine:

• A clearly defined outline of who the owners of the business are and what are their individual interests in the business

• Who can or cannot buy a departing owners’ share of the business

• What events will trigger for the Agreement to become effective and put into action. Usually this includes death, disability, retirement, divorce, and bankruptcy.

• How the business will be valued – eg, book value, agreed value, appraised value or in terms of capitalised earnings, remembering that there will be different tax implications for different methods of valuation.

• What price will be paid to the outgoing owner, and how will it be calculated.

• How the payment to the outgoing owner, or their family, be undertaken.

What is a Funding Agreement?

As mentioned earlier, a well thought out and well-documented Buy & Sell Agreement must be accompanied by a Funding Agreement.

Buy & Sell Agreements are usually funded by insurance policies. There are a number of ways this can be done, but the most common method is where the triggered buy-out is funded with life insurance on the participating owners’ lives. Policies can be held by the owners of the business on behalf of each other.

With this method, when a business owner dies or is permanently disabled, insurance payouts can be used to purchase shares in the business rather than be forced to take out a loan to buy the remainder of the business shares to pay the exiting or deceased owner which may put pressure on the remaining owners and could cause the business to suffer.

Depending on the owners and their circumstances, the policies can be held under other more suitable arrangements.

Where there is not a Buy & Sell Agreement and Funding Agreement in place in a multi-owner business, and a triggering event occurs, especially in the case of an existing owner wanting to leave rather than having to leave; this lack of contingency planning can lead to conflict and dis-trust between the owners which could have devastating consequences to the profitability and future of that business.

Buy & Sell Agreements, together with a Funding Agreement, can reduce the level of stress, conflict and unnecessary complications involved in replacing a business partner in your business. These Agreements will ensure the best possible outcomes for the business, the owners and their family. It will provide the remaining owners with the means to retain ownership and control over their business, whist avoiding severe impacts on the business. For the exiting owner and their family, it will provide them with security and peace of mind.

Paul Baggetta, Founding Partner and Principal of Baggetta & Co, has been a Taxation Accountant for over 32 years, a qualified Financial Planner since 1998 and in 1983 qualified as a Real Estate Licensee and holder of a Triennial Certificate.