What is a Buy-Sell Agreement?

What is a Buy-Sell Agreement?

Your life insurance keeps your family’s lives financially protected after you have passed on. But what about your business? If something were to happen to you, how do you ensure that your business stays well and running? If you have a buy-sell agreement in place with a business partner, you can keep your business and your family financially secure after your death or are forced to leave the company. For this reason, these legally binding buy-sell agreements are called ‘business wills’.

Some Reason Why You Need a Buy-Sell Agreement

  • Without specifying a ready buyer for your business in advance, you or your heirs may not receive fair compensation when you exit.  Thus creating an avoidable financial loss.
  • The business could wind up in the wrong hands, like the angry spouse of a former owner.
  • Your business could die in the courts while surviving owners or heirs are contesting their rights and entitlements.
  • If you or your heirs are forced to find a buyer for the business on short notice, expect the sale price to be far below fair market value.

How Does a Buy-Sell Agreement Work?

Buy-sell agreements are often executed with life insurance policies because they cover the funding very well. In a situation where there are co-owners of a business, each partner purchases a life insurance policy in the other owner’s name. If that owner passes away or is forced to leave the company, the policy holding owner can use the life insurance death benefit to purchase their share of the company. This is called cross purchasing. The life insurance works much like personal life insurance and key person insurance, with underwriting and premiums.

Buy-sell agreements can work for any type of business. A small partnership business or a collectively run corporation and anything between can have buy-sell agreements. Smaller businesses with four owners or less typically do cross purchasing for the buy-sell agreement. This is the most common type of buy-sell agreement since it isn’t overly complex, it’s easily funded through life insurance.

Large corporations with many sizeable shareholders often opt to organize a stock redemption plan instead of cross purchasing life insurance policies. In this case, when a shareholder dies, the company buys their stock from their surviving heirs and family with life insurance funds and liquidates them. Since stock redemption plans involve the transfer of a company’s own assets and market pricing, the IRS will examine this option more closely than cross purchasing for taxes.

Some Scenarios Where it Would be Wise to Employ a Buy-Sell Agreement

  • You want to stipulate that remaining owners must buy the interests of an exiting or deceased owner to ensure liquidity.
  • You want to establish a value of a share in your business god forbid there is a dispute between the owners.  If this dispute turns out to be irreconcilable and one owner wants to exit the partnership, there is a value in place
  • You want to stipulate that owners or their estates must sell their shares of a business back to the business, so the remaining partners can keep control of the company when an owner dies, becomes incapacitated or exits for any other reason
  • You want to place restrictions on other owners who may seek to sell their interest to another person that may not have the best interests of the remaining partners in mind.

If you have any questions to see if a buy-sell agreement is right for you please call us at 212-573-5564.