Buy-Sell Agreements – Preventative Medicine for Business Continuity

Ok, I admit it. I was recently drawn into watching one of the ubiquitous legal shows on TV the other night. (Hey, at least it was not CSI Topeka.) This particular episode revolved around a successful business with two partners. As the story unfolded, one of the partners experiences an untimely demise and the surviving partner is now a partner with the deceased partner’s wife. The balance of the show is filled with the requisite banter, scheming, and underhanded tricks, but ultimately the newly forged (however forced) partnership works out their differences and make for a good team. The misadventure ultimately ends well.

Buy-Sell-AgreementHowever, after having observed situations such as this in real life in my work as a financial planner, I can confidently say that the endings are rarely light hearted or happy. In fact, this scenario often results in a great deal of personal and financial stress for the surviving partner in addition to the deceased partner’s beneficiaries. Additionally, the employees of the business are often subjected to additional stress and worry. Remember, uncertainty and lack of continuity in a business is never a good thing and can be paralyzing to an organization.

Fear not, there is hope! The impact from the death or removal of a co-owner, be it a shareholder, LLC member, or partner, can be softened in a time otherwise marked by a high degree of stress. A properly drafted and up-to date Buy-Sell Agreement helps plan for and eliminate almost all of the business continuity issues related to the death of a co-owner. In its simplest form, Buy-Sell Agreements obligate the deceased shareholder’s estate to sell the deceased shareholder’s interest in the business to the remaining shareholder(s) and also obligate the remaining shareholders to purchase the interest at a pre-determined price or formula. This arrangement is called a Cross Purchase Buy-Sell arrangement. Alternatively, in a Stock Redemption Buy-Sell agreement, the deceased shareholder’s estate is obligated to sell the deceased shareholder’s interest to the business, which again is also obligated to purchase the interest. Additionally, there are many hybrid versions of the two above mentioned methods that address specific situations and continuity goals of the parties involved. Each method produces different tax and ownership consequences for the surviving owners, so it is very important to involve financial, tax and legal professionals in this process, but the overarching point boils down to certainty. Installing a Buy-Sell Agreement that is tailored to your business partnership and preferences creates certainly and clarity on potentially sensitive topics, such as valuation and timing. In a time of great upheaval in a business, having a tool that helps facilitate a sound continuity plan is of great value and well worth the effort.

All this being said, I would be remiss if I did not at least address another serious problem upon the death of an owner. The death of an owner who is often an integral part of the success of the business can have a devastating financial impact on the business. This comes at the same time the remaining owner(s) of the business has (have) to come up with additional funds to purchase the deceased owner’s interest. There is a solution: life insurance. Life insurance can be purchased to help fund the Buy-Sell Agreement as well as help provide funds to ease the impact and assist in the transition and continuation of the business. The details of the amount, type and ownership arrangement of the insurance need to be carefully thought out and planned relative to the Buy-Sell Agreement in place and the specific needs of the company. Again, all advisors, including insurance professionals, should be consulted and included in this decision process. In conclusion, as devastating as a death of a co-owner can be for all involved, there are ways to mitigate some of the uncertainty and adverse financial consequences that come with this situation. Not that this will make a difficult time any easier, but at least it will help minimize ancillary issues that inevitably would arise without proper planning.

 

Scott D. LaValley

Managing Director

Baldwin & Clarke Advisory Services, Inc.