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What is a Buy-Sell Agreement? | A Guide for Business Owners

If you are a small business owner, a buy-sell agreement is essential to protecting the business you’ve worked so hard to build. So, what is a buy-sell agreement? It’s a lot like a will, but for your business. A buy-sell agreement is a legally binding agreement that dictates what will happen to your business in the event that you or one of your partners dies, retires, or is in a life-altering situation.

A buy-sell agreement is essential for any business that has co-owners, partners, or shareholders, but it can be just as important for sole proprietorships as well. Let’s review what you need to know to get started.

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Wait…What Happens If I Don’t Have a Buy-Sell Agreement?

A lot can go wrong if you don’t have a buy-sell agreement for your business. Here are just a few scenarios to consider:

  • Your business partner passes away and the only documentation you have is his will, which states that all of his assets go to his wife. That means his wife now owns 50% of your business and has the freedom to do anything she’d like with that half, including selling it to the buyer of her choice.
  • Imagine the same scenario as above, but this time your partner’s assets go to his 3 children. You now have 3 different people (with 3 different opinions!) dictating the future of your business.
  • Your wife is the sole owner of a successful business when she unexpectedly passes away. 20 employees are now out of work and all the value she has built up is destroyed unless you can find the perfect buyer or figure out how to run the business yourself.

A buy-sell agreement saves you from all of these scary what-ifs. It enables a smooth transition of ownership, ensures business continuity, and ultimately protects the financial interests that you and your family have built up through the business.


Map Out Your Triggering Events

An effective buy-sell agreement has two key components. The first is the legal ownership component.

Your buy-sell agreement should outline exactly what should happen to each owner’s portion of the business in the event of death, disability, retirement, or other triggering events, such as divorce or bankruptcy. Will ownership be transferred? If so, to whom? What other details need to be ironed out now to minimize disruptions later? Each triggering event may require its own unique plan.


Outline How Transactions Will Occur 

The second thing to consider is the transactional component. An effective buy-sell agreement will iron out two key financial concerns:

  • Business Value Method: How the value of the business will be determined at the time of the sale to ensure each party gets a fair price? Methods can include fixed prices, appraisals, or formulas based on financial metrics such as book value, earnings, or a revenue multiple.
  • Funding Strategy: Each owner needs to be financially prepared to purchase of the departing owner’s interest at any time. Common options include cash reserves, installment payments, or life insurance policies on each business owner.


4 Types of Buy-Sell Agreements to Consider

Not all buy-sell agreements are created equal. Your attorney, financial advisor, and CPA can advise you on which agreement type to set up based on the size of your business, your financial goals, and other factors.

  • Cross-Purchase Agreement: Each business owner agrees to buy the interests of any co-owner who wishes to sell or is compelled to do so by certain triggering events.
  • Entity-Purchase or Redemption Agreement: The business entity itself agrees to buy the interests of any owner who departs under the specified conditions.
  • Hybrid Agreement: A combination of cross-purchase and entity-purchase agreements, where a portion of the interests are bought by the remaining owner(s), and the rest are acquired by the business entity.
  • Wait-and-See Agreement: Neither the partners nor the business entity are specifically named as the purchasers. Instead, when needed, the agreement adapts to either a cross-purchase or entity-purchase, depending on what is most beneficial for the business at that time.


How Often Should I Update My Buy-Sell Agreement?

When your day-to-day is relatively consistent, a good rule of thumb is to review your buy-sell agreement annually. As your business grows, your buy-sell agreement should evolve with it.

However, be on the lookout for certain triggers that should prompt you to review and update your buy-sell agreement immediately. These events could be business-related, like losing a key employee or bringing on a new partner. But they could also be personal. Changes in your family life, like divorce or a spouse’s passing, could alter the terms of your buy-sell agreement.


Should I Use a Buy-Sell Agreement Template?

There are many DIY buy-sell agreement templates available online. However, you should strongly consider the value of your business—what it means to you personally and financially—before you put your fate in the hands of a template.

Rather than relying on a buy-sell template, it’s wise to consult with three key advisors:

  • Your financial planner – It’s your financial planner’s job to help you identify all the risks at stake with your business and help you create a baseline buy-sell plan for helping you achieve your goals as both a business owner, family member, and aspiring retiree. He or she can also advise you on the best funding strategy for your buy-sell agreement.
  • Your attorney – Once you understand your financial risks and goals, your attorney can help you understand your legal risks and goals and draft a legally binding agreement that’s unique to you and your partners. A template is fairly limiting, but with a custom-drafted agreement, you have the freedom to outline just about any terms you want.
  • Your CPA – A good financial planner and attorney will also recommend you consult with your CPA before signing on the dotted line. The terms of your buy-sell agreement could have tax implications that you have not considered. Your CPA can help you avoid any costly tax-time surprises when it’s time to buy or sell.


Get Started On Your Buy-Sell Agreement Now

Don’t leave your business to chance. Schedule a get-to-know-us meeting with Advent Partners today. Our Certified Financial Planners specialize in financial planning for business owners like you.

Plus, with our Out-of-Office Advocacy approach, we proactively work with your attorney and CPA to make sure your buy-sell agreement is fully designed to protect your best interests. Together, we can make sure you, your family, and your business are ready for good.


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