The most trending tax and financial industry issues.

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Lane Keeter, CPA

Partner: Tax Consulting, Estate Planning, and Heber Springs Managing Partner

Buy-Sell Agreement – Do You Have One? Does It Need Updating?

If you are a business owner, for your own good as well as the health of the business, a properly drafted buy-sell agreement is a wise tool to have in place. This is especially true if there are multiple owners involved in the business.

Just as important as having one to begin with is the need to periodically review and revise the agreement to adapt to changing conditions and needs.

A buy-sell agreement legally confers on the owners of a business (or the business itself) either the right or obligation to purchase the interest of a departing owner. Another important use of a buy-sell is to make sure that control of the business is restricted to specific individuals, be it current owners, specific family members or even upper-level managers.

Additionally, a buy-sell agreement can be used to effectively establish a purchase price for the interest being sold in an agreed upon manner. For instance, maybe you want to engage a qualified appraiser to determine the value of the business when you first adopt a buy-sell agreement, and occasionally thereafter to make sure the price keeps up with changes in the value of your company. Or, if amenable to the parties, perhaps the value is set at some agreed-upon multiple of revenue. These are just two examples of many possibilities, and what is best depends your particular circumstances and maybe even the industry in which the business operates.

Buy-sell agreements can also be very useful in effective estate planning and in the settling of estates.

The enforcement of a buy-sell agreement kicks in typically with a life event that triggers it. Events to consider as possible triggers to write into the agreement include:

  • Death,
  • Disability,
  • Retirement or separation from the business,
  • Change in marital status and
  • Conviction of a crime, loss of professional licensing or actions unbecoming to the business.

Frankly, any number of things can be written into these things; these are just a few of the most common.

There are several ways to structure a buy-sell agreement.

In a redemption, the agreement permits (or may require) the business itself to buy out, or redeem, the owner's interest.

This is as opposed to a cross-purchase agreement, in which the remaining owners are the ones that are permitted or required to purchase the interest of the owner who is selling.

The agreement could also be a hybrid of the above. For example, it may require the selling owner to first offer the ownership interest to other existing owners, and then if no one bites, the company is on the hook to redeem the interest.

Of course, buy-sell agreements have to be funded in some way. Life insurance is very commonly used as a source of funding, especially when death is a triggering event. Some businesses will establish a reserve fund that is contributed to from time to time to meet the need, while others plan on simply funding the buyout over time from the future cash flow of the business.

As I hope you can see, a buy-sell can be extremely valuable, but is also something with long-term implications and not to be entered into lightly. Much consideration needs to be given to the trigger events you want written into the agreement, whom it will cover (and be offered) and how it will be funded.

And, as previously stated, this is not a "set it once and forget it" kind of deal. You will need to revisit the agreement periodically to make sure it still meets your needs and will serve as intended.

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