A buy-sell agreement is a legally binding contract which protects the interests of the company’s owners and permits the business to continue in the event of the death, disability, or retirement of a business owner. A buy-sell agreement, commonly referred to as a buy-sell arrangement, is drafted by an attorney and can be implemented with all forms of companies including, partnerships, limited liability companies, and corporations. A buy-sell plan can be thought of as a written agreement to help a business navigate a successful business transition.
Buy-Sell Agreement Conditions
Buy-sell agreements are custom tailored to meet your company’s objectives. However, there are certain conditions that are covered under every buy-sell agreement. Some of the most important provisions of a buy-sell agreement are covered below:
- A buy-sell agreement stipulates that if an owner plans to leave the business or sell their interest, that they must first offer it for sale to the remaining owners or back the business itself.
- The buy/sell arrangement outlines the specific instructions for handling the dissolution of the business.
- The agreement stipulates the valid reasons for termination of the agreement.
- A buy sell/agreement established pre-determined formula to determine the fair market value of an owner’s interest that can be used at the time of death or disability. This allows a definitive price to be set for the buy-out of the deceased/disabled owner’s business interest.
- The buy-sell arrangement is based on a current business valuation which establishes the fair market value of the company and is the basis of the price and terms of sale when applicable. There are also provisions in the agreement to update the business valuation periodically.
- The agreement identifies the seller and mandates that he must sell his interest and also identifies the buyer and mandates that he/she must buy the interest when made available.
- The buy/sell arrangement lists potential funding mechanisms such as life insurance and disability income insurance.
For more specific details see a Sample Buy-Sell Agreement.
Advantages of a Buy-Sell Agreement
A buy sell agreement has numerous advantages for any business. Below are the major advantages to establishing a buy-sell arrangement.
- Provides a smooth transition and continuity of management and ownership to the remaining business owners.
- Peace of mind and security for the business, the business owner’s and their families.
- Creates an instant market for a business interest that may not otherwise be saleable.
- Provides the liquidity to the retiring owner or to his estate in the event of death.
- Spells put the terms of payment and is easily funded with life insurance and disability insurance, if desirable.
- Establishes a fair market valuation for federal estate tax purposes that is binding on the IRS.
Buy/Sell Agreement Funding with Life Insurance and Disability Insurance
Your business has several potential solutions to fund a buy-sell agreement in the event of a disability, death or retirement of a business owner. These include using personal funds, financing the purchase out of company cash flow, borrowing the funds, establishing a sinking fund, creating an installment sale (make payments) or buying life and/or disability insurance on the life of each of the business owners with the express goal of using the proceeds to buy-out the business owner or his/her family. You can also use a combination of any of these options.
By far the easiest and most cost effective means to fund your buy-sell agreement is with life and disability insurance. The chief reason is that life and disability income insurance will provide the liquidity to fund a buy-sell agreement at the exact time the funds are needed. If your business partner dies, a life insurance policy can guarantee that cash will be available to fulfill the terms of your buy-sell agreement. Additionally, some forms of life insurance policies grow cash value that can be used to purchase your retiring partner’s interest. Finally, a disability buy-out policy can be purchased to guarantee cash is readily available in the event of a long term disability to your business partner. And the best part of all is that it is the cheapest way to assure a smooth transition for your business. For these reasons, Life and disability insurance policies are the perfect vehicles to fund buy-sell agreement and to cover business succession risks.
A buy-sell agreement is a legal document that is entered into between owners of a business or company. It is designed to provide an outline for handling the contingencies of a death, disability or retirement of a business partner. They are custom drafted by an attorney to meet the specific goals and objectives of the business. If you are a partner or shareholder in a successful company, a buy-sell agreement is critical to assuring a smooth transition in light of a partner’s death or disability. Life and disability insurance are the absolute best ways to fund buy-sell agreements because they are relatively inexpensive and provided the liquid funds exactly when needed. Call MEG Financial today at (877) 583-3955 with question on business planning and using life and or disability insurance to fund your buy-sell agreement.