A buy-sell agreement is a legally binding document signed by owners of property (typically a business) placing certain restrictions on the transfer of property and requiring specified actions upon specified events. In its most common form, a buy-sell will require surviving owners to buy and the estate of a deceased owner to sell his or her business or real estate interest.
Aside from death, other typical purchase-triggering events include retirement, disability, bankruptcy, loss of professional license, divorce and voluntary termination of employment.
ADVANTAGES OF A BUY-SELL AGREEMENT
A properly arranged buy-sell agreement protects business and remaining owners from inactive, uninformed, and potentially dissident shareholders and helps consolidate control in the hands of the agreed upon group. It also keeps ownership out of the hands of unexpected outsiders such as a co-owner’s creditor, a trustee in bankruptcy or ex-spouse.
Active owner-workers can be sure that their incomes from the active business will be commensurate with their increased responsibilities and workloads, and their efforts will not go to someone who adds no value to the business.
A buy-sell agreement will help fix the value of each owner’s business interest. It can also help avoid costly, time consuming, and aggravating litigation with both other owners and the IRS.
A binding agreement between the owners provides a market at a reasonable and fair price for what otherwise might be an unmarketable interest. To the extent the agreement is properly funded, estate liquidity problems created by the inclusion of the business in the gross estate are eliminated.
From the viewpoint of the heirs of a deceased business owner, a buy-sell severs their dependency on the surviving owners and the economic fortunes of a business that has lost a key person.
DISADVANTAGES OF A BUY-SELL AGREEMENT
The agreement is useful only to the extent adequately funded on the date of the “triggering event.”
The agreement must meet the requirements of complex tax and other laws, and thus it may be complicated and expensive to have drafted.
A buy-sell agreement is only as good as the price (preferably price setting formula) is fair to all parties. This means such agreements must be revisited and thoroughly reviewed at least every three years.
WHEN THE BUY-OUT TAKES PLACE
No one knows whether the buy-out will occur:
At a voluntary withdrawal of an owner prior to retirement
At normal retirement age, as planned
The owner has become disabled and can no longer work
An owner can no longer contribute capital as required
Because the owner has died or is terminally ill
The owner’s stock would be involuntarily transferred (such as to a creditor or ex-spouse)
What is certain is that one of these events will occur!
So ideally, the buyer’s obligation will be funded in a manner that is easy for the parties to understand, is low cost, is easily administered, and will not adversely affecting the working capital or credit position of the business or professional practice.
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