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When you own a business, you work hard to make sure that it runs successfully. But, in the unfortunate event of one of the business partner’s demise, disability, or retirement, things can go terribly wrong for your business, as well as for the rest of the business partners.
This is where a buy-sell agreement comes in. It helps business owners protect their business and family members if something unanticipated occurs.
We’ll cover this in more detail in today’s article. Let’s dive in!
Buy-Sell Agreement, what is it?
A buy-sell agreement is a legal contract. It outlines the process for the transfer of a company’s ownership or shares when one of the partners is no longer a part of the business. So, it helps in the reallocation of ownership rights. This contract outlines who would own what if one of the partners decides to leave the business or in case they suffer from an incapacitation. It also outlines the worst-case scenario, what happens if one of the partners passes away.
So, a buy-sell agreement is more like a will, or a prenup that protects the rights of all the business partners involved. This legal document allows each business owner to establish a reasonable sale price while keeping in mind the financial interest of all partners. Instead of having these decisions made by a court, the decisions can be predetermined in this one document.
Why Do You Need a Buy-Sell Agreement Important for Your Business?
A buy-sell agreement ensures a smooth transfer of ownership of the shares if a partner passes away or chooses to leave the business. In the event of their death, the partner’s business-owned insurance policy is used to buy the shares; if the partner quits, their shares are either sold back to the company or to the remaining partners.
This helps avoid costly legal battles for the control of surviving heirs or spouses on business operations. Therefore, every business, whether a sole proprietorship, partnership or closed corporation, should have a buy-sell agreement from its onset. You can say that this legal document works as a succession plan, exit strategy, and contingency agreement to make sure that the ownership of the business is smoothly transferred.
Common Triggers That Put Your Buy-Sell Agreement in Effect:
- Death or disability
- Partnership breakup
- In case one of the partners decide to leave the business
- In case one of the partners take an early retirement
- In case one of the partners is forced to make an exit due to major disagreements
- Bankruptcy
The Importance of a Buy-Sell Agreement for Business Owners
A buy-sell agreement can help you with your business’s legal and financial planning, especially if you have multiple partners on board. If you are still unsure why you need a buy-sell agreement, here are a few compelling reasons to have one for your business from day one:
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Sets the Fair Value of Your Business Shares
A buy-sell agreement sets a fair price for the shares to be sold now or in the future. All parties and partners become aware of the agreed-upon value, and since it’s in writing, nobody can financially challenge the set cost. This prevents disputes, fraud, and other legal complexities during the ownership transition. Besides, it also ensures that all partners and concerned bodies receive a fair share upon liquidation.
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Creates an Exit Plan
Transferring ownership or a partnership breakup can become messy if no legal precedent is set in place. This legal document allows the partners to split company shares per terms and conditions and avoid such disruptions. A buy-sell agreement ensures the partner leaving the company to abide by the set rules.
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Overcomes Financial Hiccups in Unforeseen Events
A buy-sell agreement helps you prepare for the future. It lets you create an action plan for smooth business operations in unforeseen events, such as the death of a partner. By setting ground rules for instances in which a partner leaves the company, becomes critically ill/disabled, or passes away, you ensure the company continues to operate and thrive in testing times.
Besides, it helps resolve disagreements among partners or multiple owners so that the company functions smoothly and everybody is on the same page regarding work processes. This helps in avoiding costly litigations your business may suffer from otherwise.
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Benefits the Surviving Owners
You may face several challenges if you don’t have a legal document that spells out how to run your business. It risks your executive board, as anyone can bring in new partners anytime. The buy and sell agreement will set out what will happen when a partner sells his shares or passes it down to next of kin. Without such a document, the company’s work processes may face disruption when a new owner joins in or takes over.
Setting Up a Buy-Sell Agreement to Protect Your Business
When drafting your buy-sell agreement, it is best to start early, just like you would with any other legal document. A well-crafted buy-sell agreement contains three essential components: a valuation clause, clear business operation guidelines, and inheritance rights that help avoid tax implications and conflicts in the future.
You will need your partners, an accountant, and a lawyer to set up a detailed legal document for long-term success. Taking care of all these aspects from the beginning, including insuring your business, helps avoid complications before any major transaction occurs. Here is a step-by-step guide to creating your buy-sell agreement that covers all financial and legal aspects of running a business:
1. Set Ground Rules for Your Business
Your buy-sell agreement should specify the trajectory of your business in unfortunate events, such as the death of the partner, sudden withdrawal or forced exit, partnership breakup, and liquidation.
This also helps set up a succession plan and stipulates control of the lenders or new partners if the company or shares are sold.
2. Invest In Life Insurance
Buying a corporate-owned life insurance policy and setting up partners as beneficiaries is imperative. This helps in purchasing shares if the co-owner passes away or leaves the company. Such financial backing ensures smooth business continuity even when one of the partners isn’t around.
3. Set Value for Your Shares
Setting a valuation clause in your buy-sell agreement is critical as it helps calculate each partner’s stake in the company. You can spell out the entire valuation methodology or create a separate document during the sale or succession.
4. Take Tax Laws into Consideration
Tax laws change every year or often when governments change. This has an adverse effect on the value of your business and may affect the sale or inheritance of shares. A clear valuation formula applicable to new tax laws can help avoid complications.
Conclusion
For the business’s success, it is imperative to operate in continuity. Multiple events and disagreements among the partners can hinder progress and affect how a business functions. A buy-sell agreement is one legal solution to such problems, creating a clear plan for succession and transfer of shares.
With this legal binding in place, you can rest assured that the future of your business is safe and secure. It spells out the course of action in unforeseen events and emergencies. Therefore, always consult an attorney to draft the agreement to cover up legal aspects before you or your partners sign up for it.
