What You Need to Know about Buy-Sell Agreements

Business partnerships can be beneficial, but they can also be messy. When someone else shares in your business success, having a formal written partnership agreement is a proven avenue for avoiding stressful conflicts. One crucial topic to cover in these agreements: buy-sell events. It is essential to detail what happens when a partner separates from the partnership enterprise.

Buy-Sell Definition

A buy-sell agreement outlines transfer of a partner’s interest in the business. It describes when and how the departing partner redeems his ownership. A number of occurrences may activate implementation of the buy-sell agreement. Each of these events is expressed in the agreement.

The agreement should also specify conflicts that compel any partner to tender his ownership. Examples include failing to allocate a specified amount of time to the business, and taking excess draws of profits relative to ownership percentage.

Triggers of Buy-Sell Events

Most commonly, the death of a partner will trigger the buyout of the decedent’s business ownership from his heirs. In addition, buy-sell agreements often come into play in the event of disability or bankruptcy. A disability is generally defined as one that impairs the partner’s ability to perform his duties to the business. In bankruptcy situations, the solvent partners need protection against an unknown party suddenly becoming a partner by purchasing the liquidating business interest in the bankruptcy process.

Some buy-sell agreements become effective in the event of a partner’s divorce. This prevents an ex-spouse from becoming a partner with the remaining business owners. Additionally, a buy-sell agreement is often implemented simply because a partner retires or no longer wishes to participate in the business.

Buy-Sell Accounting

Essentially, buy-sell agreements identify how remaining partners acquire company shares owned by the departing partner. Purchase of an exiting partner’s ownership is typically not made by the partnership; rather, the individuals who will continue owning and operating the business make the acquisition. Company cash isn’t used unless it’s first distributed to the remaining partner, who then uses it to buy out the selling partner. Correctly accounting for these steps is essential, and the tax implications are tricky.

Price is usually determined by a business valuation conducted by an independent third party. The value determined for the departing partner’s ownership is often too expensive for the remaining owner to pay with cash. Consequently, seller-financing terms are commonly arranged.

A buy-sell agreement may contain stipulations that the partner who’s leaving must provide financing to the buying partner, or a discounted price based on a present value calculation at the time of the partner’s departure can be embodied in the agreement. This makes procurement of outside borrowing easier on the remaining owner.

Frequently, insurance is obtained for funding the purchase price when executing a buy-sell agreement – especially in the event of a partner’s death.

With much to consider in the structure of these agreements, professional counsel in these matters is vital. It is highly recommended business owners contact their financial adviser before entering a partnership or arranging any buy-sell agreements.