and Sell Agreements
Many businesses, especially
partnerships and corporations with a small number of shareholders, use
contractual arrangements to control what happens if one owner dies or
becomes disabled, wants to sell his/her interest or to handle a situation
where the owners wish to go separate ways.
This article describes
some of the issues associated with this type of arrangement, called a
buy/sell agreement. If your business has multiple owners, you may want
to consult an attorney and have an agreement drafted.
Generally, a buy/sell
agreement can be used to prevent the disruption of the business when there
is a forced change in ownership. It can be used to identify how ownership
can pass, how the business should be valued and may even include details
on how the funding of a buyout may be established. Three of the main benefits
of having a buy/sell agreement in place are:
- It can provide
for the stable continuance of the business.
- It can provide
a valuation process.
- It can help solve
estate-planning issues for the owners.
When a major owner of a business dies, becomes disabled or retires, having
a plan in place can avoid the chaos often found in such a situation. A
buy/sell agreement may provide for the remaining owner(s) to buy the departing
owner's interest. It could also provide for the business (if a corporation)
to buy back the ownership, or it could provide for the ownership to be
sold outright. Imagine the situation where a partner dies and all of a
sudden one of his children decides to start taking an active role in the
business with very little training or experience. Having an agreement
in place can prevent this potential disaster.
Most small businesses are hard to value. Without the presence of a major
owner, they can be even more difficult to value. Many buy/sell agreements
include some form of valuation model that can be used as part of the process
of passing ownership. It may be a flat dollar value, some multiple of
earnings or cash flow, an appraisal method to be used or some other formula
driven method. Buy/sell agreements can also be drafted to create a situation
where the value is based what one owner is willing to pay the other owner
for his interest. In such an arrangement, Partner A could offer to buyout
the Partner B for $XX. Either Partner B accepts the offer of $XX or must
sell his interest to Partner A for the same $XX.
Many business owners face difficulty in creating effective estate plans.
Three of the issues that cause the most difficulty are what happens to
the owner's ownership interest in the business, how the interest should
be valued for estate tax purposes and if there funds available to pay
any estate taxes that may be due. A contractual buy/sell agreement can
set the rules for the transfer of interest in the business. If the agreement
has a valuation method included, that method may become the basis for
valuing the business for estate purposes. The IRS doesn't have to accept
the valuation method, but often does if the method is reasonable. Finally,
if there is a sale process set out in the buy/sell agreement, that process
may also include details on the new owner paying for the interest and
therefore providing money to pay any estate tax that may be due.
If your business has multiple owners, you should probably have some form
of contractual buy/sell agreement in place. Being prepared for the unexpected
is good business. The process of creating the agreement will also probably
result in the owners having frank discussions about the future of the
business and that too is good business. Given the permanent nature and
importance of a buy/sell agreement, using a qualified attorney is also
a good idea.
Many small businesses
are highly dependent on the presence of a key employee or small group
of employees for the ongoing operation of the business. It may be an owner,
partner or some other important person. Protecting the business against
the untimely death of that person with some type of life insurance policy
can be wise. In fact, some lenders may require such an arrangement.