What is a buy-sell agreement?
A buy-sell agreement is a document that designates how one partner's share in a business will be distributed in the event he or she dies, becomes disabled or wants to leave the business.
A buy-sell agreement is essential for your business owner clients.
As a life insurance producer, your job is to help them understand how important it is to protect their investment.
And this legally-binding document is one of the ways they can avoid losing control of their company, or losing it altogether.
The bottom line is that your clients who own businesses need your advice on this topic. In this blog, we’ll discuss what a buy-sell agreement is, why your clients need one and how to get started.
Buy-sell agreement: The basics
Let’s get a clear definition of what a buy-sell agreement is.
This document designates how a business’ assets will be divided in the event that someone decides to dissolve it, a partner wants out or a co-owner dies or becomes disabled to the point that they can no longer be involved.
You could think of it as a cross between a will and prenuptial agreement.
It explains in detail who owns what in the business so that these particulars don’t have to be decided by the court or an executor.
The document spells out an agreeable sale price for a co-owner or partner’s interest in the business, including how and when those shares will be disbursed to the person who has been designated to receive it.
A buy-sell agreement is a necessity
Why do you need a buy-sell agreement?
- To secure a fair value cost for shares in the business
- To create an exit strategy for partners
- So surviving owners keep their control
- To develop a plan for business continuity
Without a buy-sell agreement, a number of undesirable situations could develop.
A deceased partner's spouse or children could suddenly have a stake in the company, including making management decisions your client and/or their partners may not be in agreement with.
Encourage your client to imagine the chaos that could come from people who don't understand the ins and outs of their business – and who may not have as much passion about it – having the power to control the future of the company.
It's also possible that a bank could have a financial interest in the business.
Any of these scenarios could result in someone who doesn't care about the company's survival having a say in what happens.
But that's not all.
Here are more reasons why your business owner clients need a buy-sell agreement.
4 reasons why this agreement is necessary
1. It secures a fair value cost for shares in the business
This information is valuable to have if your client or another partner wants to stick with the business after a fellow co-owner passes away or leaves the company.
It prevents disagreements about fair pricing for a buyout by setting the number at an agreed-upon amount – before anything happens.
With a buy-sell agreement, no one should expect more compensation than what all the partners think their portion is worth.
2. It creates an exit strategy for partners
The end of a partnership can be complex.
If the split is over a disagreement, for example, it can be difficult to find common ground and agree on terms if there aren't ground rules already in place.
A buy-sell agreement eliminates the confusion of trying to decide on terms in the heat of the moment when tensions may be high.
Everyone wins when business owners simply plan ahead.
3. It allows surviving owners to keep their control
Just like the examples above, the last thing your client wants is a business partner they didn't sign up to work with.
With a buy-sell agreement, there’s no risk of a random next-of-kin stepping into the company and causing disruption – or even dissolving the company if they decide to sell.
Your clients put their heart and soul into their work. Help them take the steps to protect their financial and emotional investment.
4. It develops a plan for business continuity
A buy-sell agreement smooths over possible disruptions and complications that could come from the death or loss of a partner.
Partners or co-owners already know which person is responsible for which tasks and the business can carry on with minimal bumps in the road.
How to help clients create a buy-sell agreement
All buy-sell agreements have the same basic features.
Here are the steps to keep in mind when you’re working with your business owner clients to set up their buy-sell agreement.
1. Start the business with a buy-sell agreement
Let your clients know that they can set up a buy-sell agreement at any point in their partnership, but it's important that they do so as early as possible to avoid any hiccups.
It's best to have the terms ironed out before the company has conducted any substantial business.
Plus, it's a little easier to handle if it's viewed as one of the many tasks they have to tackle when starting a business.
2. Establish ground rules
Creating a buy-sell agreement is one thing. Executing it is another.
The document needs to be realistic and practical for the company. Encourage partners to think about potential scenarios, such as under what conditions they would consider selling the business.
Take the time to be thorough and help them make the decisions everyone with a stake in the business can all live with if it becomes necessary.
3. Protect partners with life insurance
Your business owner clients may not know that it's common for business partners to purchase life insurance policies on each other when they create a buy-sell agreement.
One of the reasons for this is to provide the surviving co-owner with the funds to buy out the deceased partner's share in the business.
4. The valuation clause is critical
This is a crucial part of the buy-sell agreement because it's the method by which the value of each person’s stake in the company is determined if one were to die or otherwise become uninvolved.
There are generally two methods used. Some businesses have their own way of calculating value, while some agreements stipulate that the decision will be made by a valuation expert when the time comes and a death or other inciting incident occurs.
5. Don't forget about taxes
Make sure your client understands that they can lose a chunk of money on the sale of their business to estate taxes. This is also true for their successors who may decide to sell.
Put a valuation formula in the buy-sell agreement that is conservative so your client doesn't have to experience taxes that would be avoidable.
A buy-sell agreement protects business investment
As many of your clients with a partnership in a business know, working with a business partner has many positive aspects, but it also forces each co-owner to make hard decisions at times.
That's why a buy-sell agreement is so important.
Your clients need to know what it is, why they need one and how to get the process started.
Whether they’re just starting a business or they’ve been in an established company, they’ve worked hard to get where they are. Don’t let them risk losing it.
Create a buy-sell agreement with your business owner clients and help them enjoy the peace of mind it gives them for the future of their company.
What are the steps for creating a buy-sell agreement?
- Start your business with a buy-sell agreement
- Establish ground rules
- Protect each other with life insurance
- The valuation clause is critical
- Don't forget about taxes.