Owning a business is just one aspect of entrepreneurship, but many contracts can be implemented when something goes wrong. A business partner could die, retire, or leave a business suddenly. This may leave the business and the remaining partners in a difficult situation. However, a buy-and-sell agreement can help structure the future of the business.
The Definition of a Buy and Sell Agreement
When a partner dies or leaves a business, there is a legally binding contract called a buy and sell agreement. This contract stipulates how the partner’s share of the business will be reassigned. Most of the time, this share is usually given to the remaining partner or the partnership, if there is one. There are four different names for this agreement:
How Does This Agreement Work?
Many businesses, such as partnerships, sole proprietorships, or closed corporations, tend to use a buy and sell agreement. People use this agreement to help transition after an owner has either died, retired, or left the business entirely. The agreement usually stipulates whether this share will be sold to the business or the remaining members.
However, when a partner dies, their proportionate share will go to their estate unless the remaining partners buy the deceased partner's share and add it to their own.
More About Buy and Sell Agreements
Two common agreements are used:
Cross-purchase Agreement: The remaining owners will buy the share of the business that has gone up for sale.
Redemption Agreement: The business entity will buy the available share of the business.
There are certain partners who decide to have a combination of both, so they can purchase a portion of the share and have the entity purchase the rest. The funds used to purchase these portions are usually a part of a life insurance policy taken out against every partner in the business.
This is a common practice because it makes it easier for the business to buy any shares it needs. However, if there is only one owner, then they can appoint a key employee who would become the business's buyer or successor if they were to die.
Why Do People Need a Buy and Sell Agreement?
There are many reasons for business owners to use a buy and sell agreement for their business.
A buy and sell agreement is a way to establish a fair value of each owner’s share. This can be useful to defuse arguments concerning the value of any partner's share.
When someone leaves the business, it can get complicated, which is why having a defined plan can help reduce the complexity of transferring ownership.
If there is not a buy and sell agreement set in place, then the business runs the risk of a new person entering the business and becoming a partner. Inside a buy and sell agreement is an outline of who will be able to purchase the deceased owner’s interest.
Things That People Need to Keep in Mind
A buy-and-sell agreement is made to help the remaining partners manage a challenging situation to protect the company's best interests. One way this can be accomplished is by having an agreement to restrict who is able to purchase equity in the business. This means that outsiders may not be able to purchase the share without the approval of the remaining owners.
It can be beneficial for businesses to have terms in place so they can control who will have a say in the business. This can keep the business and partners in a fair standing because it could require the approval of other partners if one would like to sell their own shares.
Additionally, a person can decide how they would like their share to be assessed. When someone dies, it can cause grievances within a business. However, when the person has already decided how they want it assessed, this can take pressure off the remaining members.
How Can the Kelley Financial Group Help?
Having someone who understands a buy-and-sell agreement can make a difference. This is because they can guide business owners toward different possible options and possibly help the owners to have flexibility down the road. The Kelley Financial Group team is here to help business owners with their planning needs.
With a team of experienced, knowledgeable, and passionate individuals, every business owner can know that their best interests are at the forefront of every decision. They understand that this business is a large part of their client's life, so they want to ensure that they are prepared for every situation thrown their way.
Making a buy-and-sell agreement can help people when it comes to a partner's unexpected death or retirement. However, if there is no agreement in place, then the rest of the partners can be left with a situation that could get very messy.
This material was prepared for The Kelley Financial Group’s use.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
The Kelly Financial Group and LPL Financial do not offer tax or legal advice or services. We suggest that you discuss your specific situation with a qualified tax or legal advisor.