BUY-SELL AGREEMENT
ENSURES SURVIVAL OF SMALL BUSINESSES
By
Many business owners and their families have discovered the hard way that an essential survival tool for a closely held business is a buy-sell agreement. Such an agreement between the owners of a company allows for a smooth transfer of ownership upon the death or disability of one of the owners. Planning ahead for occurrences such as these can minimize business risk.
There are two basic kinds of buy-sell agreements: nonfunded
and funded. This column will focus on nonfunded
buy-sell agreements.
Owners may be underestimating their importance to the business by not
protecting it in the event of their death or disability. The business would
suffer from a loss in productivity, while the remaining partner(s) could still
be paying a percentage of the profits to the heirs. The company might not
survive such a shift in responsibility and loss of resources.
Buy-sell agreements ensure that the stock of a deceased or withdrawing
shareholder will not be sold to an outside third party before the other shareholder(s)
have a chance to buy it. Without a buy-sell agreement, the heirs of the
deceased can technically sell their shares of the business to anyone, including
family members of the deceased, parties who are not qualified to run the
business or even to the competition. Important decisions like hiring and
firing, changing salary levels, as well as when to pay dividends, could be
influenced by forces outside of the remaining partners' control.
A buy-sell agreement can provide a market for the stock of each shareholder in
the event of death, disability, or retirement. It can be used to establish the
value of the business for the IRS and for estate planning purposes. Therefore,
these factors have important tax implications for business owners.
Preparing a business valuation helps in the estate planning process. Without a
business valuation or a formula for calculating the business value, the IRS
will tax the estate on the basis of its own business valuation, which can be
much more costly. Normally, businesses use a general business valuation model
to calculate the value. The buy-sell agreement should recommend that the
valuation be updated on an annual basis.
Although a nonfunded buy-sell agreement does not
provide for the accumulation of funds or acquisition of insurance to cover the
cost of transference, it is still a valuable business and estate planning tool.
It states the intention to continue the business after the death or disability
of the owner and places an agreed-upon value on the business.
In order to avoid unnecessary hardship on family and colleagues, the buy-sell
agreement should answer as many questions as possible, including setting a time
frame for the transference of ownership, naming the key owners and specifying
each one's percentage of ownership, and outlining all privileges and rights
granted to key owners.
Disability issues can be even more complicated than an owner's death.
Statistics show that during their working lives, individuals are more likely to
become disabled than they are to die. A disabled owner may still be legally
entitled to receive a salary.
As a result, the business may suffer the loss of a productive employee and the
corresponding loss in the revenue they generated. It may be possible to hire a
replacement for the disabled owner. However, then the business will be paying
two people while only receiving the work of one. How long can a business and
its remaining owner(s) afford to do this?
For all of these reasons, it is important to include the issue of disability in
the buy-sell agreement. For the maximum benefit, the agreement may often state
that if an owner is disabled for more than a specified number of months, the
disabled owner will agree to sell the company back to remaining owner(s).
For a smoother transition of business
ownership upon death or disability, now is the time to formalize your plans
with a Buy-Sell Agreement.
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