Buy/Sell Agreements are contracts entered into by business partners who undertake to be bound by each other’s interest in certain life events such as death, divorce, retirement, bankruptcy or long-term disability, which can lead to the need to replace a business partner and acquire their share of the business.
Life events are often linked to a business owner’s life insurance policy so that the remaining business partner has the money to buy out the other partner’s interest in the business. The majority of Buy & Sell Agreements are flexible enough to accommodate a variety of business structures such as companies, partnerships and trusts. They are more commonly used by small businesses that have more than one co-owner.
Funding a Buy/Sell Agreement
Buy/Sell Agreements are usually funded by life policies. There are a number of ways this can be done.
Policies can be held by the owners of the business on behalf of each other. This is the most common arrangement known as a cross-ownership agreement. Thus when a business partner dies or becomes injured, insurance plans can be used to purchase shares in the business.
Partners can also hold policies on behalf of themselves as principals. In some circumstances, one of the owners will hold policies on behalf of all the other owners which is known as a discretionary trust. Finally, the company may hold policies on behalf of the owners.
Why should I have one?
Buy/Sell Agreements simplify the task of deciding who will run the business when one partner is no longer able to. When a business partner dies, the heirs to the business may be too young to take the reins or might be uninterested in doing so. In any event, a Buy/Sell Agreement will take precedence over a Will. This can avoid unwanted involvement in the business from inexperienced family members who have been left an interest. Surviving partners are also safeguarded against ending up with a new business partner they do not want.
Without a Buy/Sell Agreement, remaining business partners may be forced to take out a loan to buy the remainder of the business shares. The interest payable under such a loan may cause the business to suffer.
What should a Buy/Sell Agreement include?
Buy/Sell Agreements should clearly spell out the owners of the business and what interest they have. In addition, the interest to be transferred must be specifically defined (in shares or units). Each agreement should also define how the value of the business is to be determined. This is important, as it has tax implications. You may wish to define your company’s value as book value, agreed value, appraised value or in terms of its capitalised earnings. For this reason, it is important to review your insurance policies frequently and create an agreement to maximize your tax concessions.
Buy/Sell Agreements can reduce the stress and unnecessary complications involved in replacing a business partner. These agreements ensure the best outcomes for your business and provide surviving partners with the means to retain ownership and control over their business.
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