Dale Brunk, CEBS, AIF®
Does your small business need a buy-sell agreement? The answer is yes — and here’s why.
IN THIS ARTICLE:
- A buy-sell agreement stipulates how members of a business should buy out interests of another member’s shares, commonly in the event of death or disability.
- Businesses should have a buy-sell agreement in place in order to avoid potential legal and financial disputes.
- There are two main types of buy-sell agreements: cross-purchase agreements and stock-redemption agreements.
What is a buy-sell agreement?
A buy-sell agreement, much like a will, is a contract that stipulates how members of a corporation can buy out the interests of a deceased or disabled member.
But a buy-sell agreement doesn’t only stipulate next steps in the case of a death or disability. It can also cover what the business should do in the event of a partner’s exit, often due to retirement or divorce.
A buy-sell agreement is most commonly used in sole proprietorships, closed corporations, and partnerships.
Why does your business need a buy-sell agreement?
Without a buy‑sell agreement, your business could face financial, legal, and tax problems if an owner leaves, dies, or becomes disabled. For example, a deceased partner’s spouse or children could unexpectedly gain a role in the business—decisions that are better made in advance with all owners aligned.
A buy-sell agreement establishes a fair value price for each partner’s shares.
Therefore, establishing a fair value price for each partner’s shares not only speeds up the buyout process but also helps avoid potential IRS disputes.
A buy-sell agreement develops an exit plan.
Don’t want until an emotionally-heightened event, like divorce, occurs to develop an exit strategy for each business partner. By setting these terms in advance, you can easily manage the next steps if a partner chooses to leave the business.
A buy-sell agreement helps to ensure business continuity.
What will you do should a business partner decide to sell, or face illness or death? This is where a buy-sell agreement comes in to lay out a plan for a company’s continuity.
What are the types of buy-sell agreements?
Businesses commonly use two types of buy-sell agreements.
Cross-Purchase Agreement
In a cross‑purchase agreement, each owner buys the interest of a deceased or disabled member, which is why these agreements work best for smaller companies where owners hold life insurance policies on one another.
Stock-Redemption Agreement
A stock‑redemption agreement allows the business—not the individual owners—to buy back a deceased or disabled member’s shares, providing cash value to the departing member’s estate.
Review or set up a buy-sell agreement with a Landmark financial advisor
Which type of buy-sell agreement is right for your business? We can help you decide. Work with a Landmark financial advisor to review or set up your buy-sell agreement.