Should You Use a Buy/Sell Agreement in Succession Planning?

Running a business requires a great deal of hard work and sacrifice. Business owners often focus on what they can do to keep their operation growing at a healthy pace, but often neglect planning for problems that could incapacitate their business if the unexpected occurs in the future. 

Regardless of the structural organisation of your business, it’s important to create a succession plan. Life can sneak up on you, and you may not have time to create a satisfactory succession plan in the future if you neglect your planning today.

One of the tools that’s often used for succession planning is the buy/sell agreement. In this article, we’ll outline how a buy/sell agreement could be a useful element of your succession plan.

 

What is a Buy/Sell Agreement?

Also known as a buyout agreement, a buy/sell agreement is similar to a Will. In fact, some people even call it a “business will.” With a buy/sell agreement in place, the death or disability of one of the owners triggers a buyout. It can also be structured so that the buyout occurs if one of the business owners wants to exit the business or is forced out.

Buy/sell agreements also protect multiple owners when one of the owner’s interests doesn’t align with the interests of others. For example, if one of the owners wants to transfer their business interests to a third party, the buy/sell agreement can dictate the rules of this transaction.

Without a previous agreement, this situation could lead to a deadlock among decision makers. With a buy/sell agreement, however, the buyout formula will have been established before the conflict emerged.

 

How Can a Buy/Sell Agreement Help Your Business?

A common problem in business succession is that when one partner dies, the children or spouse of the deceased partner now claim a substantial share in the business, but don’t always have the operational knowledge or financial acumen required by the business. This puts the remaining partners in a difficult situation; sharing ownership with unprepared and underskilled individuals. 

A business can’t survive long under this kind of strain and resulting internal conflict, but this difficult situation can be avoided with the help of a buy/sell agreement.

Referring to the previous example, if the partners had created a buy/sell agreement that contained a buyout price or that calculated a formula to value the shares held by each partner, the surviving owner would have an ensured balance of authority for making decisions. Also, everyone (the surviving owner as well as the grieving family) would be able to rest assured that they receive fair value for their shares in the business. 

Having a buy/sell agreement in place can also reduce stress while owners are all actively working on the business. When all parties feel mutually respected and secure in their future positions, they’re more likely to work cohesively.

 

What are the Costs of Having a Buy/Sell Agreement?

In most cases, it doesn’t cost a lot to set up a buy/sell agreement. Most of the costs are incurred when the agreement is triggered. In many cases, business owners don’t have the personal capital to buy out their partner’s shares or support a transition of leadership. Some people use life insurance or disability insurance to fund succession planning.

Other costs of buy/sell agreements could include legal and financial services for hidden issues such as appraisals, business valuations and attorney’s fees.

 

Should I Use a Buy/Sell Agreement?

Each business is different, and what works well for one may not be the best solution for another. But many businesses find that buy/sell agreements are effective tools for their succession planning. 

If you have business partners, you should look into using a buy/sell agreement. Discussing the agreement will give you and your fellow owners a chance to discuss important questions about what to do if you have an unresolvable conflict and someone decides to leave the business. You’ll also get to discuss what should happen if one of you suddenly passes away or becomes disabled. Will a spouse enter the business leadership? Will that person’s shares be paid out to the family? 

These are important discussions to have, and they’ll be covered when you work out your buy/sell agreement. For more information about succession planning, or to talk with one of our business experts about another topic of concern, get in touch with us at Altus Financial. We look forward to speaking with you.