What happens to a multiple-owner business when one of them chooses to retire or must leave suddenly for some other reason?
Charles Sims Jr., CFP
It’s often easier to decide exactly how a business should proceed long before something life changing happens, when the potential effects are still hypothetical and reciprocal. A properly drafted buy-sell agreement is a binding contract that establishes how ownership shares should be transferred when specified triggering events occur, and it may provide a mechanism for determining the value of transferred shares.
Several ways to go
A buy-sell agreement can be structured to fit a business’s unique circumstances and typically may be used by any business entity, including corporations, partnerships, LLCs, and even proprietorships. Basic buy-sell agreements include:
Cross-purchase agreement: Stipulates that the remaining owners will purchase the interest of the departing owner.
Redemption agreement: Provides for the business entity to purchase the interest of the departing owner.
Hybrid agreement: The business itself has the first option to buy, but if it declines because it is more advantageous for the shareholders to buy, then the shareholders are the purchasers.
Execution is everything
Pre-arranging for the business or the partners to buy out a departing owner may be a good idea, but it could prove fruitless if the sale is unexpected and the buyers don’t have the money to close a transaction. For that reason, it may be helpful to fund a buy-sell agreement with life insurance and/or disability income insurance. The guaranteed liquidity from the policies may help prevent survivors from being forced to sell assets or borrow money.
The cost and availability of insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing an insurance strategy, it would be prudent to make sure that you are insurable. Any guarantees are contingent on the claims-paying ability of the issuing insurance company.
(Charles Sims Jr. is President/ CEO of The Sims Financial Group. Contact him at 901-682-2410 or visit www.SimsFinancial Group.com. The information in this article is not intended to be tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor.)