Do I Need a Buy-Sell Agreement?

SBLI of Massachusetts

December 15, 2010

There are many ways to structure the ownership of your business. If you choose to be the only shareholder in the company then you run your company alone, and have no business partner to consider when making decisions. You can also easily set up a plan to pass the ownership of your company down to your estate after your death. If you choose to share ownership with another person, you will have two shareholders forming a partnership. This partnership creates a union between two people, each with their own unique set of talents, strengths and experiences. Like a marriage, a partnership works best when one partner complements the other and brings another point of view to the table.

But a partnership can complicate things in the event of the death of one partner. The remaining partner may wish to assume full ownership of company shares at the time of death, but might not have the liquid funds available to buy them from the deceased’s estate. With proper planning you can resolve this ahead of time by putting a buy-sell agreement in place. A buy-sell agreement ensures that the family of any deceased partner gets fair market or book value for their shares of the business, and the surviving business owner obtains full ownership.

What is a Buy-Sell Agreement?
A buy-sell agreement is a contract between shareholders* that guarantees if one dies, the other will buy out his or her shares. The agreement infers that the inheriting family members or estate will agree to sell, and the surviving owner agrees to buy. This agreement is usually funded with a life insurance policy. This way, when one partner passes away, the death benefit of the life insurance policy covers the responsibility of the surviving partner to buy the shares of the business.

Considerations
One of the most important considerations in structuring a buy-sell agreement is whether to fund the agreement for fair market value or for book value.

Book value: The value of the company based on the balance sheet. This will roughly equal the net worth of the company for the percentage held by each shareholder.

Fair market value: Fair market value is determined by an independent party. It eschews emotion and simply represents what an unattached, but interested, party might pay.

Another consideration is the condition under which the buy-sell should be executed. Death is not the only incapacitation that can be suffered by a business partner. Disability, retirement, or resignation can all be actionable events in the agreement, but these events cannot be funded by life insurance.

*In a company with more than two shareholders, the agreement would be called a cross purchase agreement.