Relationships, be they personal or all business, are hard. There are intricacies associated with all partnerships that can make things difficult. For many, the benefits of a partnership far outweigh any associated challenges. This is especially true of business partnerships.
As a small business owner with a co-owner or multiple partners, you are probably well-acquainted with the challenges that come with having someone else to share your business failures and successes with. But it is also important to recognize that a business partnership is also a legal relationship.
As a result, you want to be sure you have buy-sell agreement in place as you start your venture.
What Is a Buy-Sell Agreement?
A buy-sell agreement is a contractual document that outlines what happens if a business owner needs to transfer his or her interest in the company. A good one will also cover when a business owner can no longer be involved in the business for any reason, including death, divorce, bankruptcy or retirement.
Why Is a Buy-Sell Agreement Important?
Putting a buy-sell agreement in place is similar to signing a prenuptial agreement before a marriage. It clearly outlines contingencies for every different outcome, including the financial implications. It helps owners understand what happens if a partner or co-owner no longer wants to be involved in the business or cannot be involved for a variety of reasons.
What Are the Key Features of a Buy-Sell Agreement?
1. It’s a Contingency Plan
Buy-Sell Agreements outline how the remaining partners of a business will purchase the shares of another owner who dies or simply wants to sell. Typically, business owners would need to have a large amount of cash on hand to make this purchase, which is often unrealistic. As a result, many businesses fund their buy-sell agreement through insurance, especially in the case of a death.
2. It Can Be Insured
As mentioned above, buy-sell agreements can be funded through insurance. Another insurance policy that small businesses might want to investigate is “key person” insurance. This policy insures against a potential loss of revenue that could result if one of the partners dies due to unforeseen circumstances. The insurance payout can help the business train and hire a new person to take the partners place.
3. It Protects You
The buy-sell agreement clearly lays out a succession plan for departing members, reducing the chance of misunderstandings or infighting that might result. Your succession plan might include transferring an owner’s assets directly to a family member or having it go through a living trust.
4. It Clearly Outlines Triggering Events
There can be any number of events that trigger the implementation of the buy-sell agreement. Some of the more common triggers include:
- Disability: If an owner has become disabled or can no longer perform his or her duties, they may need to be bought out to preserve the integrity of the business.
- Divorce: In the case that one of the owners gets a divorce, it might be within the organization’s best interest to simply buy the owner out. This prevents the business from being used as collateral or an asset during the divorce proceedings.
- Debt: In a substantial number of situations, small business owners are the personal guarantors for business loans or debt. If the owner defaults on a loan, even a personal one, it can compromise the business. In a partnership, since one’s ownership stake in the company could be liquidated to pay off bad debts, it would be prudent to include a clause that deals with this possibility.
- Conflict: If a dispute cannot be settled between the owners, the subsequent tension and non-communication can severely limit the business’ performance. How a buyout should proceed in the case of such a dispute should be included in the agreement.
- Retirement: In the case of retirement, the departing owner can still receive a payout for the shares he or she owns, but the remaining owners should also be able to reclaim that owner’s interest in the company.
- Death: In the case of an owner’s death, the buy-sell agreement—as well as individual life insurance policies—will cover the large buyout that will be due to the surviving family members as the death benefit.
Remember to Update It
It’s best to keep the buy-sell agreement up-to-date by revising it every three to five years. In that time, growth or devaluation of the company could result in the parameters needing to be changed. It’s especially important for organizations that experience rapid growth to revise their buy-sell agreement, as you don’t want to be bound by an outdated agreement that doesn’t reflect changes in the state of your company.
If you’re thinking of starting a small business and intend to have co-owners or partners, be sure to consult with an attorney and get your buy-sell agreement reviewed. You don’t want to leave anything to chance and risk losing the business you’ve worked so hard to build. Click here to download a buy-sell agreement template you can use for your partnership.
If you’re ready to set up a partnership, continue on to our guide to forming a general partnership.