by Steve Whitehill
At the most basic level, a buy sell agreement is a contract that outlines the sale of an owner’s share of a business. Buy sell agreements are sometimes referred to as buyout agreements. These agreements may be used for a number of reasons. Examples include retirement, bankruptcy, death, and unresolvable conflict with another owner. In any case, a buy sell agreement protects an owner from the associated risks should any of the events listed above occur.
When a buy sell agreement is written properly, it leaves little to no question about what happens next when an owner wants to or is forced to leave their share. It is a proactive approach to keeping the business on a safe course.
How to Prepare a Buy Sell Agreement
- Identify events that will activate the agreement
As mentioned above, there are multiple life events that can put a buy sell agreement into effect. You should speak with the other business owners to determine which are relevant to you. If one of you is married, divorce may be something to consider. If your job requires physical labor, disability may come into play. Death is almost always unexpected and should be discussed upfront. - Establish the buyout structure.
The most popular structure is a cross purchase plan. This arrangement requires each owner to agree to purchase the others’ share should that individual die or undergo other life events which would trigger the agreement. Another example is an entity redemption plan, which would require the business to buy the parting owners’ share, but through a life insurance policy. Lastly, there is a one way buy sell plan. This option means that a sole proprietor leaves their business to a family member or employee. That heir would purchase an insurance policy on the owner and act as the sole beneficiary. Depending on your business and unique situation, each option has its own benefits as well as disadvantages. - Conduct a business valuation.
You’ll need to determine exactly what your business is worth in order to establish individual share values. This is where we come in. Our business valuation calculators can tell you what your business is worth with just a few quick questions and the click of a button. You’ll be able to get a net estimate as well as the SDE or income of up to $5,000,000. Simply use the form here or contact us to get started. - Determine funding.
Should an event take place that puts the agreement into effect, a buyout will need to be funded in some way. It’s important to establish where that funding will come from and make it part of the agreement. Funding can come from a number of different sources, including life insurance, a loan, sales installments, cash, or even stocks.
In conclusion, a buy sell agreement is an important part of setting your business up for future success. There are many details that can go into the agreement, but the outline above should help get you started. Contact us for more information.
