Divorce – an unexpected death, disability, or retirement – an irreconcilable dispute. Any of these events may put your successful, stable business into a tailspin. Luckily, a buy-sell agreement can help you and your business be better prepared to handle these events.
What is a Buy-Sell Agreement?
A buy-sell agreement is a legally binding agreement between co-owners of a business that controls what happens if a co-owner leaves the business—think of it as a change management tool.
What Should a Buy-Sell Agreement Consider and Include?
We’ve created this checklist as a starting point for discussing business transition. These topics will help you identify the goals, needs, and commitment levels of individual business owners as well as the goals and needs of the business itself. Discussing these matters with your co-owners will help you identify planning opportunities and minimize the risk of future business disruption or, worse, business failure.
The Buy-Sell Checklist
◻ Are there any non-owners on the management team?
◻ Do all of the owners participate in management?
◻ Are there procedures in place to help ensure continuity of management during a transition?
◻ Do the transition procedures take into account key employees who are not owners?
◻ Do any key employees have stock options, profit interests, or any instrument convertible to equity?
◻ Is there a possibility of deadlock (for example, 50/50 ownership)?
◻ Is there a workable mechanism to resolve a potential deadlock?
◻ Does your buy-sell cover the nine common triggering events?
o Termination of employment
o Sale to a non-owner (right of first refusal)
o Marital dissolution
o Expulsion of an owner
◻ If a triggering event occurs, will the buyout be mandatory or optional?
◻ If a triggering event occurs, how will the value of an interest be determined? By formula? Appraised value? Predetermined price? Other (documented) method?
◻ If a triggering event occurs, how will payment be made for the departing owner’s interest? May a promissory note be used to pay over time? What is the down payment, interest rate, and term of the note? Is the note secured or unsecured?
◻ Will the parties use life insurance to fund the buyout obligation? Who will own the insurance policies? Who will be the beneficiaries?
◻ What are the tax consequences of the buyout? Are there any gift and estate tax consequences? Will there be any basis step-up? Will the receipt be taxable? If so, will it be capital gains or ordinary income?
◻ Are there any professional licensing considerations to ensure that the equity passes to a qualified owner?
◻ Do the owners want to restrict the transfer of ownership interests? Are all transfers prohibited unless approved by the other owners? Or are certain transfers (such as to family or to a revocable trust) permitted without owner approval?
◻ If the business is taxed as an S corporation, do the owners understand the importance of including provisions that restrict the transfer of equity to ensure that the business does not become disqualified from Subchapter S status?
◻ Do the owners want to restrict issuing new equity?
◻ Do the owners want to give preemptive rights when issuing new equity?
◻ Do the owners want to provide drag-along rights to facilitate a sale of the entire business to a third party?
◻ Do the owners want to provide tag-along rights to protect minority owners if the majority owner decides to sell to a third party?
◻ What type of business is this?
◻ Do you currently have a signed buy-sell agreement?
◻ Who manages the business?
◻ How do the owners want to address employment issues, such as:
o Non-competition agreements
o Non-disclosure agreements
o Non-solicitation agreements
o Protection of intellectual property and intangible assets
Here’s What to Do Next
Spend a few minutes going through the checklist and list of key considerations. If you want to protect your business, but your business doesn’t have a buy-sell agreement or you’re not sure the buy-sell agreement you currently have in place is adequate, give us a call.
We will review this checklist with you to either let you know whether you’re protected with your current buy-sell agreement or help you design and draft a comprehensive agreement that protects you and the business.
This post is for informational purposes only and is not intended to be construed as written advice about a Federal tax matter nor legal, tax, financial or any other advice that can be relied upon by the reader. Readers should consult with their own professional advisors to evaluate or pursue tax, accounting, financial, or legal planning strategies.