Bert and Ernie, best friends since grade school, decide to quit their day jobs as software developers and go 50/50 as partners in a new venture developing games for mobile devices. Their first couple years are a success, they’ve come out with some amazing Apps and are projected to make a killing on the iTunes App Store. Unfortunately, Ernie passes away. Bert still wishes to continue to grow the business he and Ernie started. However, is Ernie’s wife his new partner? Is Ernie’s wife interested or possess the acumen to be a partner? Can Bert buy her out? If so, on what conditions? What if Ernie didn’t pass away, but was severely injured in an accident and could no longer participate in the business? What if the situation was reversed and Bert passed away?
Both partners would have been well served in putting a buy-sell agreement in place to avoid this situation. Regardless if you own all or only a part of your business, in the event of your death, disability, divorce, insolvency or retirement you need to consider a plan as well as the funding in place to ensure that your interests can be purchased. It doesn’t matter what type of business you own, your education about buy-sell agreements needs to start now.
Here are 5 questions about buy-sell agreements you should consider.
1. Do I have a will for my business?
Just as it is important for you to have a will to ensure your desires for disposition of your assets are met when you die, a buy-sell agreement is the will for your business and will eliminate plenty of heartache when a person dies. It certainly will make situations like the one between Bert and Ernie’s wife smoother. Regardless of the type of business – sole proprietorships, partnerships or corporations – the death or disability of the owner or a partner or shareholder must be considered. Which individual will be the one responsible for purchasing the partner or shareholder’s share? At what price? When?
2. Do I desire continuity?
Ernie’s death may have also been perceived as a loss of a lot of good will by external business partners, suppliers and/or creditors. Not to mention the fact that employees may be inclined to move on as a result of Ernie’s passing. A buy-sell agreement provides a plan for a smooth transition when tragedy occurs in addition to funding the buyout of partners and/or shareholders to ensure that business will continue. Buy-sell agreements resolve plenty of issues with employees, family members of the deceased, creditors, and suppliers.
3. Does the size or structure of my business matter?
Certainly the larger the organization or the more partners or shareholders involved the more sophisticated a buy-sell is required. However, buy-sell agreements are appropriate in any business where there is two or more partners or shareholders. On the death of a partner the partnership will dissolve so it is extremely important in those situations to have an agreement in place. However, it may even be appropriate in the case of a sole proprietorship where an agreement to sell the business to a key employee in the event of the owners passing is put in place as he may not have family members to succeed him in the business. Simply put, a buy-sell agreement is appropriate to any size or structure of a business if the owner, partners, or shareholders wish to fund the purchase of their interest.
4. Good idea, but where am I going to get the money to fund a buy-sell?
If you’re sold on the idea you need a buy-sell agreement, then you might be asking yourself where you would come up with the capital to fund the deceased partner’s buyout. Insurance provides an excellent solution when it comes to funding buy-sell agreements. Life insurance, for example, will help to resolve liquidity issues when it comes to buying the other partners share of the business without impairing the company’s working capital. If Bert and Ernie were to have taken life insurance policies on each other’s lives, then Ernie’s wife would receive the death benefit in exchange for Ernie’s share of the business.
5. That sounds expensive, what’s the outlay?
A buy-sell agreement can be extremely complex. The are many issues to be considered, and many unseen issues will arise. Thus, the fee to have a qualified lawyer prepare a buy-sell agreement is likely to be at least several thousand dollars. However, the benefits certainly will outweigh the costs. Remember, what a life insurance funded buy-sell agreement will provide:
- It will ensure the working capital for the business will remain as is.
- It will will ensure the business has a guaranteed buyer at a fair price.
- It will ensure that the family of the deceased or disabled owner is provided with funds in exchange for their interest in the business.
- It will ensure that your employees, creditors, suppliers and customers will not see any disruption to the operation of the business should a tragedy occur with one of the owners.
5. Okay, what next?
Consult your financial advisor. She can introduce the various methods for a buy-sell agreement and assist in putting the funding in place. They will also likely recommend a lawyer specializing in business or tax to assist in drafting the actual agreement.
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