There are times in a business where the business owner is no longer able to run the company which can leave the other business partners in a very awkward situation. Events such as death, divorce, retirement, bankruptcy or long-term disability can lead to a need to replace a business partner and acquire their share of the business.
Buy/sell agreements are contracts entered into by business partners who undertake to be bound by each other’s interests if these events occur. They are often linked to a business owner’s life insurance policy so that the remaining business partner has the money to buy out the other partner’s interest in the company. The majority of buy/sell agreements are flexible enough to accommodate a variety of business structures. So they can apply to companies, partnerships and trusts and are most commonly used by small businesses that have more than one co-owner.
As stated above, buy/sell agreements are usually funded by insurance policies. There are a number of ways in which this can be done.
Policies can be held by the owners of the business on behalf of each other. This is the most common arrangement and is often known as a cross-ownership agreement. When a business partner dies or becomes injured, insurance payouts can be used to purchase the parties share in the business.
Buy/sell agreements simplify the task of deciding who will run the business when one partner is no longer able too. When a business partner dies, the heirs to the business may be too young to take the reins or might not be interested in doing so. In any event, a buy/sell agreement will take precedent over a will. This can avoid unwanted involvement in the business from inexperienced family members who have been left an interest. Surviving partners are also safeguarded against ending up with a new business partner that they do not want.
Without a buy/sell agreement, remaining business partners may be forced to take out a loan to buy the remainder of the business shares. The interest acquired from a loan may cause the business to suffer.
It is important that these agreements clearly spell out the owners of the business and what interest they have. Furthermore, the interest to be transferred must be specifically defined i.e. shares or units. Each agreement should also define how the value of the business is to be measured. This is important as it has significant tax implications. You may wish to define the business value as book value, agreed value, appraised value or in terms of its capitalised earnings. It is important to review your insurance policies frequently and create an agreement to maximise your tax concessions.
Overall buy/sell agreements can reduce the stress and unnecessary complications involved in replacing a business partner. This agreement ensures the best outcome for your business and provides surviving partners with the means to retain ownership and control over their company.
As accountants, we do not prepare the buy/sell agreements, this is a job for a solicitor. However, it is important that we work closely with your solicitor when having these agreements drafted.
Please contact Ellingsen Partners to discuss how a buy/sell agreement might apply to your circumstances.