Critical Considerations When Drawing Up a Buy-Sell Agreement
One estate planning tool that can protect your family and partners is a buy-sell agreement. This legal document gives owners the first chance to buy an interest in the company if another owner pulls out or dies. Ideally, these contracts are drawn up when a business is launched, but they can be entered into later.
Note: Most buy-sell terms are incorporated in the operating agreements for an LLC or the shareholder agreements for a corporation.
But don't wait too long. If you die without an agreement, it may be difficult for your heirs to know how to handle important matters that could have a significant effect on the value, continuation or disposition of your business. Further, if your partner dies, you may be stuck with new, unexpected partners.
Even if you stay with the company for decades, the time to prevent disputes is before they occur. Minimize legal fees, as well as sleepless nights, by solving "what if" issues now.
Ask these questions to determine where you need professional assistance to prevent future problems:
Should the agreement apply only to the current owners — or should it be binding on all owners throughout the life of the business entity?
Should the agreement supersede other agreements to redeem a business interest?
Is the agreement reviewed annually? (Changes in price or terms should require a unanimous vote of the owners. This is where many disputes occur.)
Type of Agreement
Should the agreement be structured as a redemption or cross-purchase agreement?
Should the agreement be structuredto require one party to sell and another party to buy? Should it give one party an option to require another to sell? Should it give a right of first refusal to a partner staying in the business? Or a combination of any of these options above?
Should the death of an owner cause an automatic buyout of the owner's interest? Or should his or her family be allowed to remain as an owner?
Price and Time
Should the buyout price from the estate or heirs of a deceased owner be addressed? What about the buyout price to a disabled owner or an owner who resigns or is dismissed? An owner who goes bankrupt? If yes, when should it be paid? What interest rate should the obligation bear?
Should there be a difference in price if there's an amiable parting of ways?
Should the price reflect the fact that you're selling to a long time business associate rather than an outsider?
Should the price reflect goodwill?
Should the agreement provide that a buyout be funded by life insurance or some other investment vehicle?
If funded with life insurance, should the type of life insurance used be addressed (for example, term life, ordinary life, last-to-die, paid-up life, universal life or an endowment policy?) Should a life insurance trust be used?
Should all of the life insurance policy proceeds be used to redeem the interest? Can part of the proceeds be used to help the entity recover from the loss of the owner?
Should whole life insurance policies with cash values be transferred to the owner at termination or retirement?
Should the agreement be guaranteed or secured?
If so, should the security be in the form of a pledge of business assets? A personal guarantee by the other owners? An agreement obligating the entity to refrain from increasing salaries, paying dividends or making loans until all outstanding liabilities to the beneficiaries are paid?
Should you address the disposition of owners' loans in the event of death or disability?
Should you address the disposition of owners' loans in the event of termination other than death or disability?
Covenant Not to Compete and Other Considerations
Should there be a covenant not to compete? If so, should there be geographic and time limitations?
Should there be a period of disability before the other owners have the right to buy out a disabled owner?
Should owners have the right to transfer or assign to a trust, for estate-tax planning purposes, their rights and interests in the business?
Should the spouses of the owners sign the buy-sell agreement?
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