When you’re a partner in a business, you put a lot on the line. Blood, sweat, tears, money, reputation – it all gets poured into your business. Why do you do it? The answer is returns, in all of their various forms – emotional and material. Buy-sell agreements are chiefly concerned with ensuring that you or your estate are fairly compensated in the case that your death or other circumstances lead to you to leave the business.
The buy-sell agreement is, in effect, a contract between you and other stakeholders in the business. They are mostly used by partnerships or closed corporations in order to ensure that transitions in ownership are smooth and agreeable to all parties. They are often used in the case of the death of a partner, so they’re sometimes called business wills. In a similar vein, you might hear the buy-sell agreement referred to as a business prenup.
There are several different types of buy-sell agreements, but they all share one common feature – they’re used to determine which entities will buy the shares of the partner who is leaving the business. Though buy-sell agreements most often contain a number of clauses, these clauses will often relate back to one of three things – what events trigger a buyout, who will buy the shares, and what price will be paid for those shares. As all of these circumstances can fluctuate over time, the buy-sell agreement will include formulae in order to determine things like share price.
Typically, shares will be purchased by either other partners in the business, or by the business entity itself. This adds a measure of protection for both the buyer and the seller. The seller is ensured fair compensation for their work in the business, while the buyer becomes less susceptible to outsiders gaining undue influence over their business dealings.
You’ll often see hybrid buy-sell agreements, which grant buying rights both to partners and to the business entity. In order to ensure there are sufficient funds in the case a buy-sell agreement is triggered, partners will often purchase life insurance policies on each other. The business may also purchase life insurance policies in order to ensure it can uphold its portion of the buy-sell agreement.
For sole proprietorships, the buy-sell agreement may be arranged with a key employee. This ensures a clear line of succession in the business.
Buy-sell agreements can be triggered by a number of circumstances, from the death of a partner to their departure for other reasons. The exact triggers for buy-sell agreements and the consequences of those triggers will vary from agreement to agreement. Buy-sell agreements have uses outside of their triggers; if there’s ever a dispute over the value of each partner’s shares, the formula used in the buy-sell agreement can be consulted.
Here at Paradigm Insurance, we offer strategies and solutions to ensure your obligations are fulfilled in the event a buy-sell agreement is triggered.