Every business owner with key employees or partners needs a buy-sell agreement. A buy-sell agreement establishes a succession plan if a partner or key employee dies, retires, attempts to sell his or her share, or acts contrary and incompatibly with the others bound by the agreement. In short, it is your Plan B when Plan A for the ownership of your business fails.
When waters are calm, owners and possibly even key employees (those without whom your company could not adequately function) agree on certain critical provisions regarding severing their relationship. Those provisions may include:
- Whether there should be a mandatory buy out upon the death of an owner.
- The owners’ opportunity for first right of refusal if someone wants to sell their ownership interest.
- The owners’ option to buy out another’s interest upon termination, disability, or retirement.
- The buyout price or formula for arriving at a price and the payment terms.
Having an agreement already in place eliminates concerns about legal recourse from a dissatisfied owner when all the terms for buying him or her out have that owner’s signature attached.
An additional benefit to a buy-sell agreement is the inclusion of life insurance. Rather than using company cash to purchase the ownership interest of a departing owner, life insurance policies purchased and funded in advance can be transferred to that owner, saving the remaining owners the burden of leveraging company ownership or paying out of pocket to buy him or her out. While this arrangement is a standard concept, it usually involves transfer taxes when the policy is reassigned, a complex web of policy ownership, and the availability of the policy cash value to creditors. I can offer a model that provides for the use of life insurance without all the typical drawbacks.