My Partner and I Don’t Need a Buy-Sell Agreement—Do We?
Yes, you most likely do! If you and one or more partners own your business together, you need to have a legally binding agreement that says how you will handle the situation if one of you unexpectedly passes away or is otherwise incapacitated.
“Oh, we’re young, so that’s not likely to happen!” Would you like to bet on that? Are you 100% certain that neither you nor one of your partners is immune to accidents or illnesses? Most likely, you’re not THAT certain, so let’s take a look at what buy-sell agreements are and why you should have one.
The goals of a buy-sell agreement are:
- To agree ahead of time on the disposition of your jointly-held assets (business and property) should something happen to one or more of you.
- To ensure, if such an event happens, that your wishes for the disposition of your share of your jointly-held assets are fully carried out as you intended.
- To fully maximize the value of your assets that accrues to you and/or to your beneficiaries.
- To eliminate or minimize as much as possible all impediments to the above.
Why Can’t I Write My Own Buy-Sell Agreement?
Forming a viable buy-sell agreement can be a formidable task. Incorrectly drawn buy-sell agreements fail for many reasons, so you want to ensure the following areas of potential risk and liability are considered:
- Inadequate funding or unworkable funding choice: Buy-sell agreements usually provide for the acquisition of the deceased partner’s assets. How will this be funded? You would want to specify how this acquisition will be funded as part of the agreement.
- Unanticipated triggering events: The obvious triggering events are unexpected death and incapacitation. But you would also want to consider how you will handle a partner’s unexpected divorce, for example. Or your partner is just tired and wants to retire from the business, but still expects a return on their share.
- Failure to consider tax consequences: The choices you make can have significant tax consequences. For example, an outright sale might be far more costly than a transfer over time.
- Inappropriate or outdated valuation methodology. How will you value the business? How often will you revalue the business? How often will you re-examine the valuation methodology to ensure it is still relevant, given other changes that may have taken place in the business or in the existing laws?
- Unclear transfer considerations/qualifications: Who will be allowed to acquire the deceased partner’s business assets? You may not want to have unqualified or uninterested relatives of the deceased partner involved in the business or demanding an immediate sale of the deceased partner’s interest.
- Conflicts between buy-sell agreement, company legal structure, and estate plans/trusts of partners: Each partner needs to have an estate plan that is consistent with the desires and goals expressed in the buy-sell agreement—and vice versa. In addition, the company’s legal structure must be aligned with the stated outcomes of each.
What Do I Need, Then?
Each of the above can be remedied by relying on experts with the knowledge and qualifications in each of the requisite areas. Unless you have the specific expertise to develop a buy-sell agreement that ensures the above goals are met and risk areas addressed, you want to assemble a team of subject matter experts to support the development of your buy-sell agreement. You want them to support you in addressing the following:
- What are the business considerations, choices, and decisions you and your partners will make? There are many choices to be made in developing a comprehensive buy-sell agreement, and you would want guidance as to the ones to consider.
- What are the possible triggering events and how will you handle unanticipated triggering events?
- Which is the best valuation methodology for your business? Are there industry standards or accepted valuation methodologies? How often will you schedule a periodic review of both the value and the valuation methodology?
- What are your options for funding the agreement upon a triggering event? A common approach is to have a company-funded life insurance policy for each of the partners that provides the funds for buying that partner’s interest upon their death.
- What are the tax considerations for the options and choices you are considering?
- What is the final form and language of the agreement? Does it capture all of the business considerations/decisions you and your partners have made?
- To ensure an effective transfer of interest, how should the property be held—under what title?
- Do your company by-laws and/or operating agreements need to be reviewed and possibly modified to fully support your expressed goals and choices in the buy-sell agreement?
- Do you understand that it is critically important to have estate plans and trusts in place that reflect the objectives and choices expressed in the agreement? In particular, you will want to avoid probate and minimize or eliminate unnecessary estate taxes.
- You may also want to consider a non-compete agreement should one of you choose to exit prematurely.
Really? All This?
Yes, really—all this! What you need to accomplish the above is: clear identification of your and your partner’s choices and options concerning the business; valuation, funding, insurance, tax, estate planning, and legal experts; coordination and facilitation of the professionals who can provide this expertise—both the experts you are working with now and those expected to work with you; and guidance through the entire process to finalize the outcome expeditiously and completely.
In summary, there is a cost to having a partner exit your business without a well-thought-out agreement. Forming an effective buy-sell agreement is a team effort, and your buy-sell advisors must work as a collaborative team focused on your and your partner’s best interests. And, finally, you may want to consider working with a qualified business process coach to ensure that your team’s output is fully aligned with your and your partner’s desires and goals, and that the agreement is both comprehensive and avoids costly mistakes.