If you have ownership in any business, partial or otherwise, you ought to have a practical understanding of buy-sell agreements. Unless you’d rather rely on good fortune for the duration of your business, you’d be wise to get one. Without this crucial, added protection, your pride and joy that you built from the ground up may end up facing both financial and tax-related problems upon an owner’s divorce, personal bankruptcy, sale, departure, or even death!
A well-drafted buy-sell agreement can shield your business from squabbling relatives, business associates, and spouses, keep the company alive so its reputation and clientele aren’t negatively affected, and escape facing issues of insolvency that can sometimes pose a threat during these turbulent times.
What business structure could benefit from a buy-sell agreement?
A buy-sell agreement is a logical step for any business model of almost any size, including partnerships and limited liability companies. These business structures all use buy-sell agreements, either by working them into the partnership agreement or shareholders agreement, or by drafting them on their own. How important it is to have a buy-sell depends on the number of partners or co-owners in the company, and any other silent stakeholders who might jump at the chance to gain some control over the company.
Example: For the last 10 years you have been partner of a kebab store with Peter with equal ownership. This arrangement might be in writing or based on trust. Peter passes away. Do you still own the kebab store? Do Peter’s relatives (spouse or child) replace him and become your new partner? Are you now under some obligation to buy their interest in the business? If so, to what value and based on whose terms and conditions? Could you break away and start up a kebab store by yourself, or are you required to continue operating the old one? What if Peter lives and you die?
The example illustrates how even the smallest of businesses could make use of a buy-sell, even as the business’ only formal document. Disagreements and misunderstandings will inevitably arise when a business doesn’t have a buy-sell in place, and the risk is obviously greater for larger companies. A buy-sell agreement can cover two co-owners or several.
Cross Purchase or Redemption?
One commonly used buy-sell agreement is a cross-purchase: if you or Peter passes away, has a disabling injury, files for bankruptcy, etc., the other has the option to acquire whatever interest the departing co-owner leaves. On the other hand, a redemption buy-sell agreement requires the company to purchase the outgoing interest, which saves the other co-owners from personally having to buyout the departing interest and fronting these costs. Both styles of agreement are flexible and the more appropriate will depend on what the co-owners agree works best for the company.
The buyout price might be determined by an independent assessment, it may be fixed or it may be based on a formula. This money might be cash, or it might be installed on a monthly basis. Different trigger events can have varied payment terms, meaning the conditions of the buy-sell may vary for divorce as compared to death.
How important is Insurance?
Insurance is a common characteristic in most buy-sell arrangements. Of course, insurance isn’t compulsory, but it can provide a financial safety net if an unexpected event arises. For example, despite who dies first out of you and Peter, having life insurance will ensure you won’t be out of pocket, which means the Kebab store won’t go under, and your spouse or nominated recipient will be paid accordingly, as per the buy-sell agreement.
The Bottom Line: something is better than nothing
It may be uncomfortable confronting these issues and making the more difficult business decisions. Having said that, it is much better to have any buy-sell agreement in place, than none at all. Plus, the upside of a buy-sell agreement is its reciprocity. It’s (practically) impossible to know, for sure, whom out of Peter and yourself will kick the bucket first, or incur a disabling injury, or divorce from your spouse. The nature of buy-sell agreements, being a mutual interest to all parties, makes it much easier to agree on the terms and conditions of such an arrangement.
Who can draft these agreements?
Most business and tax lawyers should be able to assist in having the most suitable buy-sell agreement drafted for your business. The good news is that these agreements can be quite affordable, despite the invaluable benefits of them. Whatever you end up paying for a buy-sell, it will be insignificant to what you could end up paying without one.
If you need a business lawyer with experience in drafting contracts to assist you with your own buy-sell agreement, LegalVision has a team of experienced lawyers ready to assist. For more information, get in touch on 1300 544 755.