Business Owners—Is Your Buy-Sell Agreement Ready to Go?
If you co-own a business, it’s important to have an up-to-date buy-sell agreement in place. Many business owners admit that they either don’t have such a document in place or, if they do, it is outdated. Without an effective buy-sell agreement, an unforeseen termination or death of an owner will almost certainly result in management gridlock or costly litigation over the affected owner’s shares.
What is a buy-sell agreement?
A buy-sell agreement is a legal agreement among business co-owners that clearly states how shareholder stock is treated in the event of an owner’s death, disability, divorce, termination or other triggering event. A well-drafted buy-sell agreement might eliminate the potential for disputes by clearly describing things like what triggering events will lead to the disposal of an owner’s shares, whether the other owners will have the opportunity to buy the affected owner’s shares before disposition to an outside party, and how to calculate the value of an affected owner’s shares.
If an owner knows to whom they want to transition their shares, is a buy-sell agreement still needed?
Yes, businesses with more than one owner should always consider having a buy-sell agreement in place. These agreements can prevent a stall in business management, as well as ensure proper valuation of a deceased owner’s shares. Also, a buy-sell agreement might enable other owners of the business to promptly purchase a deceased owner’s shares according to a predetermined formula, which can prevent the shares in question from being locked up in litigation or potentially in the hands of someone the other owners do not want to have involved in the business.
Once a buy-sell agreement is in place, does it ever need to be updated?
These agreements should be reviewed frequently to ensure they remain accurate and are still functioning in the best interests of both the business and its owners. If a buy-sell agreement is not reviewed regularly, the fair market value of the owners’ shares may not be properly reflected in the document. Should a triggering event occur, this discrepancy in value could result in lost generational wealth because of an outdated valuation formula.
To determine if an agreement is still effective, it’s typically a good practice to calculate the value of the business as if a triggering event has occurred. If the business owners are comfortable with the resulting value, the valuation formula should be acceptable to leave in place.
Despite knowing the importance of a buy-sell agreement, many businesses fail to implement one. Yes, there is time and money involved with getting an agreement completed, but a well-drafted document might help save a business from management gridlock and costly litigation in the event of an unforeseen event that will negatively affect the ownership group in some regard.
ABOUT THE AUTHOR
Matt Foltz, CPA, CFP, CEPA, MS in Accountancy
Matt is an Associate Partner, Wealth Advisor in our Itasca, IL, office. He also serves on the Investments team. Previously, Matt worked at legacy firm BDF, where he sat on the firm’s Financial Planning Committee and led many of the firm’s tax-related initiatives. He has a passion for building strong relationships with his clients and helping them make sound decisions. Matt holds the Certified Exit Planning Advisor® designation, which helps him advise business owners on how to exit their business and prepare for retirement.
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