The One Business Risk You’re Ignoring: Why Every Owner Needs a Buy-Sell Agreement (Before It’s Too Late)
I recently had the opportunity to speak to a group of around 20 successful business owners - I asked them a two-part question:
By a show of hands, how many of you have spent a week on vacation in the last year?
Most all hands in the room went up.
Then I asked:
Now for those of you with your hands raised, how many of you have spent a week working on your buy/sell agreement?
All hands but one went down (which just so happened to be a business owner we work with).
We all know buy/sell agreements are important (especially those who have multiple partners) but we don’t ever get around to completing them.
From the conversations I’ve had I typically find it’s one or a combination of:
It’s a secondary priority relative to running the business.
It’s hard to find and trust the multiple professionals to work through this with.
It’s a tough and potentially awkward conversation.
They’re right.
But consider the alternative…
I know from a recent experience through someone who owned a business who passed away suddenly - no estate plan & no buy/sell agreement.
What happened?
For starters, the business goes through probate but there’s a 9-month creditor open window to make a claim against the estate before assets can be probated.
In the meantime - the business didn’t just stop running when the owner passed.
There was a team who needed to get paid, client’s to be served, business decisions to be made, and bills that needed to be paid.
Internally, there were talks of an employee becoming a partner - but nothing got around to be formalized.
The owner’s spouse will inherit the business - but has no formal practice in the field of business.
There’s family members who are involved in the business - but are separate from the individual who was in talks of becoming a partner.
Naturally, there’s plenty of concerns here:
As the business continues to operate without a formalized owner, who is authorized to make key business decisions in the meantime? Can the company pay bills, make payroll, or make key decisions?
What happens to business value if competitors poach customers or employees as this drags on further?
The spouse may want to sell their stake, but without a formalized buy/sell agreement, how is valuation determined? Who will buy it?
Further, by the time probate allows for a business valuation, market conditions may have changed, potentially lowering the company's value.
How will profits be distributed?
Does the employee promised ownership cause a legal battle in courts? If so, how does this impact company morale?
Does the family member involved in the business gain ownership over who was promised ownership?
For many business owners, their business represents ~80% of their net worth.
If you have a family or anyone who relies on you - you owe it to them to create and maintain a buy/sell agreement.
An effective buy-sell agreement will include:
Triggering Events – when is a buyout required? Examples include, death, disability, retirement, divorce, bankruptcy, or voluntary sale.
Valuation Method – how will you value the business - formula, independent appraisal, book value, etc.
Funding Mechanism – how is the buyout funded? Examples include life insurance, disability insurance, installment payments, or company reserves.
Buyout Structure – this would consider whether remaining owners (cross-purchase) or the company (entity-purchase) will buy the departing owner’s shares.
Restrictions on Transfer – Prevents unwanted third parties from becoming owners, can also include existing owners first right of refusal.
Dispute Resolution & Deadlock Provisions – how are problems solved in conflict before problems occur & dealing with 50/50 ownership.
Payment Terms & Timeline – how is the deal structured, what’s the timeline, how are rates determined?
Tax Considerations – with the goal to minimize tax, this could be looking at either an asset/stock sale, installment sale, preservation of S-corp status, qualified small business stock exemption.
Periodic Review Clause – how often do you review the buy-sell provided things change?
One common thing I find is someone will have a funding vehicle but not the actual buy/sell agreement in place.
This is common if you run into someone who does insurance before you run into a financial planner.
A funding vehicle is important - but if there’s not a legally binding document outlining what someone is to do with that capital - then you could run into a scenario where someone can use that money for alternative use.
Further - it’s extremely rare to need a permanent life insurance policy for your buy-sell.
Term insurance will provide you with the most coverage at the lowest cost - objectives achieved.
Drafting and finalizing a buy-sell agreement is hard.
But not having a buy-sell is far harder when it’s too late, the cost isn’t just financial, it’s chaos, conflict, and potentially the collapse of everything you’ve built.