The Critical Role of Buy-Sell Agreements in Business Succession Planning

Welcome to the ninth part of our business succession planning series! If you’ve been following along, you already know how crucial succession planning is for small business owners. We’ve covered how to set up a framework for your business’s transition and integrate estate planning into that process. You also know that your legal entity type will play a big role in shaping your strategy. In our last post, we discussed using trusts to plan for your business’s future. Today, we’ll look into another key tool in your succession plan: buy-sell agreements.

What Is a Buy-Sell Agreement?

Business exits typically happen for one of the "five Ds": disaster, disagreement, divorce, disability, or death. These are major life events that no one wants to think about, but as a business owner, it’s critical to prepare for them. After all, your time with the business you’ve built will eventually come to an end, likely due to one of these factors. So what happens to your ownership stake then?

Without a solid succession plan, the future of your business could be left to legal defaults, especially after you pass on. The impact will vary depending on your business structure:

• Sole proprietorship: When the owner passes, the business legally ends, and employees can’t continue running it.
• Partnership: A partner's death may mean the partnership dissolves.
• Professional Corporation: While the business doesn’t automatically end, operations can be disrupted, especially since many states restrict ownership to licensed professionals.
• LLC: The business can continue, but what happens next depends largely on the terms of the operating agreement, if one exists.

A buy-sell agreement is a legally binding agreement that determines how the value of your shares will be handled if you exit the company. It is a business succession tool that facilitates the smooth transfer of ownership to the remaining co-owners, heirs, or third parties, preventing disputes.

Key Components of a Buy-Sell Agreement

So, what exactly goes into this agreement? Let’s break it down:

• Triggering events: These are the circumstances that activate the agreement. Whether it’s the death of an owner, disability, voluntary exit, or divorce, the agreement ensures that ownership transfers seamlessly when needed.
• Valuation and pricing: How much is your ownership stake worth? A buy-sell agreement outlines how to determine the fair market value of the departing owner's share, ensuring that all parties get a fair deal.
• Funding the agreement: Without funding, it can be difficult for remaining business owners or heirs to buy out the departing owner's shares. Common funding methods include life insurance, disability insurance, cash reserves, or installment payments.
• Successors: The agreement also designates who takes over and how new ownership is approved, ensuring your business lands in the right hands.

While buy-sell agreements vary in complexity and nature depending on the type of business involved, the listed four components form the foundational aspects of a robust agreement.

The Benefits of Business Succession Planning With Buy-Sell Agreements

Incorporating a buy-sell agreement into your business succession plan comes with several key advantages:

• Ensures continuity and stability: A solid buy-sell agreement clearly outlines who will take over your business after you leave. This means the people running day-to-day operations can keep doing what they do best, ensuring your company doesn’t miss a beat.
• Maintains your legal structure: For an S corporation, a buy-sell agreement keeps ineligible shareholders from acquiring stock, which is crucial for preserving your business’s status. Partnerships can avoid dissolution, and professional corporations can prevent non-professionals from becoming stakeholders, keeping everything running smoothly.
• Minimizes disputes: With a clear plan in place for transferring ownership to surviving owners, a buy-sell agreement reduces the risk of messy legal disputes between business partners and heirs. Everyone knows what to expect, which leads to less conflict.
• Sets a fair value for your business: Your buyout agreement ensures that your ownership interest is properly valued. This way, your heirs or partners can buy or sell shares at a definitive price, avoiding disagreements over worth.
• Protects remaining owners and heirs: By setting up mechanisms like life insurance or cash reserves, a buy-sell agreement ensures there’s enough money to buy out your shares. This means your heirs or remaining partners won’t have to scramble to cover the cost.

Conclusion

Now that you clearly understand how buy-sell agreements work and the benefits they bring to your succession plan and business interests, you may be ready to create one for your business. These agreements can be complex, especially when it comes to the financial and tax planning involved. To ensure you get the most out of your agreement, it’s a good idea to work with legal and tax professionals who can guide you through the process.

We invite you to join us next week for another insightful piece where we’ll cover the recent Supreme Court ruling that may affect how buy-sell agreements are funded. Are you wondering about any of the issues mentioned above? Please email us at info@wilkinsonlawllc.com or call (732) 410-7595 for assistance.

At Wilkinson Law, we give business owners the clarity they need to fund, grow, protect, and sell their businesses. We are trustworthy business advisors keeping your business on TRACK: Trustworthy. Reliable. Available. Caring. Knowledgeable.®