If you have business partners, chances are there will be ownership changes somewhere in the future. You or one of your partners may move out of state, pursue a new business opportunity, become disabled or die, or, the goal of all you techy startups, seek to sell to an outsider (Hopefully, with Instragram-esque success).
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What happens then? Do your business documents provide the procedures? Some do, but others don’t. The buy-sell agreement (or buyout agreement) is a contract among the owners that controls the process of buying and selling ownership interests. Think of it as a prenup for your business. Sometimes, the buy-sell is part of your operating agreement or bylaws, but it can also be a standalone document.
The buy-sell agreement helps insure that you or your partners aren’t forced to work with strangers. It gives the remaining owners the right to determine who they want to work with, and helps determine the price for the buyout. In the case of a death of a partner, the partner’s heirs may not be willing to work for the business, and you may not be able to force them to do so. But you will be paying them you former partner’s share of the profits.
So who doesn’t need one?
You may not need a buyout agreement if you’re the 100% owner, or your business partner is your spouse or child.
If you’re the 100% owner, you can do these things yourself when the time comes. You may want to consider a buy-sell agreement with an employee who will buy the business upon your death or retirement. This is a great reward for a hard-working employee, and gives your family an infusion of cash upon purchase.
If you’ve got a great, stable marriage, neither of you is probably going anywhere without the other. If either of you dies, the surviving spouse will probably inherit your half of the business. But, if you haven’t been married long or the marriage is on shaky ground, the buyout agreement can save you the money and time of having lawyers litigate the issue down the line.
If you’re in business with a child, or a parent, you probably don’t need one either. You can arrange the transfer through your will or through a trust. But again, if your child dies or wants to leave the business before you, what happens? A buyout agreement can address these terms.
Financing a Buy-Sell Agreement
Let’s say your partner gets hit by a bus and dies. Ouch. According to your buy out agreement, you’re entitled to buy-out her share for $1 million. You’ve got to come up with the money in 90 days. Where does that money come from? Will it come out of your revenues? Do you have that much cash in your personal emergency fund? Burdening your revenues probably isn’t the best idea, and if you don’t have enough cash or other liquid assets to cover the purchase, you should have insurance.
For this and other similar business transactions, you should ensure that any significant losses are covered by insurance. In this instant-death-by-bus scenario, an insurance policy could cover your purchase, and your business should never miss a beat. Insurance will pay you, then you’ll pay your partner’s estate. You’ll be the complete owner, and can move the company along. If you’ve got policies like this in your business, make sure you’ve spoken with a business insurance professional.
Buy-sell agreements and the insurance policies which support them are a key part of reducing risk and protecting your assets should the worst happen. If you’re lacking these documents, now may be a good time to discuss options with your partner, an attorney, and qualified insurance professional.