Serving as a legally binding contract, buy and sell agreements or buy-sell agreements stipulate how each partner’s part of a business should be reassigned should something like a death occur among the partners.
Small businesses in particular are often unaware of the importance of these agreements. However, they are vitally important to the continuation of a business if one of the partners becomes unable to serve their role due to an unexpected death. In addition, buy-sell agreements can serve as contracts funded by a life insurance policy that will detail how businesses separate ownership as well as assist if one of the partners divests. Consequently, they can serve as an exit plan for those who have a stake in the business. This use is uncommon; however. (A buy-sell agreement does not need a funding mechanism to be valid.)
Why Buy-Sell Agreements Are Important
As mentioned above, even for small businesses, or perhaps, especially for small businesses, this type of legally binding contract is vitally important. Consider this: Do you get along with your business partner’s spouse? Why, you might ask does this matter? Well, it matters because if something happens to your current business partner, their spouse will become your new business partner. Thankfully, having a buy-sell agreement in place before this happens will prevent potential legal conflicts down the road as it will ensure the right individuals receive the correct amount of shares in the business should something unexpected happen to an owner.
How To Create A Buy-Sell Agreement
Begin by looking at all the parties involved. Take a good, hard, yet honest look. Consider any and all potential areas of risks and possible scenarios that could occur. You then will want agreements set in place for how much money and to who receives the resources set in place before said event or scenario happens.
Furthermore, you should consider purchasing a policy for each of the owners, with death benefits equal to the estimated value of their interest in the business. Most business owners choose one of the two most common types of buy-sell agreement life insurance plans:
- Cross-purchase plan: This means the remaining business owner or a spouse will receive the death benefit accordingly.
- Entity-purchase plan: The business takes the death benefit.
Keyman policy is a life insurance policy that will finance a business to adjust to new leadership if a key income generator unexpectedly passes away.
Disability provisions should also be incorporated in buy-sell agreements for things such as income replacement, overhead expense payments and ownership interests. Here are some disability insurance options to consider including in your agreement.
- Disability Income Insurance: This insurance provides a monthly benefit to replace income paid to a disabled person
- Business Overhead Expense Insurance: Rent, utilities, salaries and other overhead costs don’t just go away when a business’s owner becomes unable to serve as leader. This insurance helps finance the day-to-day costs of running a business when the owner is disabled.
- Disability Buy-Out Insurance: If a disabled owner is unable to fulfill their role as owner, disability buy-out insurance can enable the business or buyer to purchase the disabled person’s interest at a predetermined payment level.
Before making a legal move, run any agreement you consider by your personal attorney. Also, make sure you do this before presenting it to fellow co-owners for their signatures. In addition, it’s wise to review your buy-sell agreement with your insurance agent and attorney at least once every five years. Your company’s value and/or worth could fluctuate over time as could the wishes and preferences of the owners. Therefore, you need to check up periodically on your buy-sell agreement to ensure that if its instructions were enacted they would serve your business appropriately.
Considerations in Buy-Sell Agreements
Remember, these contracts are designed to help partners manage difficult situations in a way that protects the business’s best interest. However, it should also protect the personal and family interests of the other partners and owners of said business. Admittedly, when all partners are young and in good health, a buy-sell agreement can seem like a needless step. However, accidents and illnesses occur every day and protecting your business and those who depend on it for their livelihood should be of utmost importance.
Bottom Line: A Buy-Sell Agreement is a Good Idea for Small Businesses
No matter how large or small your business, a buy-sell agreement is a good idea. Keep in mind, your agreement documentation should make it clear to all parties how ownership will be divided should certain situations take place. Our team at Winter-Dent knows the importance and legal risks involved when it comes to buy-sell agreements. Reach out to our team today to find the best strategy for your business.