Small businesses even sole proprietorships and joint partnerships are potentially immortal entities. Their owners, unfortunately, are not. That’s why many small businesses operate under buy-sell agreements, which can be a smart approach to succession planning.
Buy-sell agreements are a lot like prenuptial agreements, in that they set up in advance a plan for breaking up a business and moving on after the partnership is no longer tenable. In business, this is usually because one of the partners dies, becomes disabled, or wants to sell his share of the business. When this happens, the other partners can use the terms of the buy-sell agreement to calculate the amount of money that share is worth, then pay off the appropriate person the retiring partner in the case of a disability or a separation, or the next of kin in the event of a partner’s death.
The details of a buy-sell agreement specify how to calculate the cash value of the stake according to a formula that everyone has agreed to in advance. This way, the surviving partners can accurately calculate the fair value of their departed partner’s stake regardless of the company’s overall assets or liabilities. The buying partners can apply the formula and raise capital to cover the cost for a quick, clean separation. If one partner has died, this money often comes from the life insurance policies the partners took out on each other to cover this exact situation. Establishing a buy-sell agreement can ensure that your business will continue to operate even after you or your other partners move on or pass away, avoiding liquidity problems and infighting among the surviving stakeholders that could tear your business apart.