6 Important Questions to Ask About Your Buy-Sell Agreement

6 Important Questions to Ask About Your Buy-Sell Agreement

Becoming a successful business owner is no small feat. You spend countless hours cultivating a profitable business model, hiring and retaining competent employees, building client and vendor relationships, and fine-tuning your marketing and branding. Once you've put in the work - and have a thriving company to show for it - it can be unfathomable to think of leaving your business in someone else's hands. Still, exit-planning is an eventuality that every business owner will have to face.

Running a business requires a lot of moving parts, the sum of which ensure that a company can continue to operate for several generations after the original owner has passed. This can be especially pressing for small business owners. As of 2018, 58% of small business owners admitted that they have no succession plan, 78% of whom blame the problem on the extraordinary time and energy commitment required to simply manage a business⁠1. With the age of small business owners averaging at approximately 50 years old⁠2, the futures of small businesses could be in jeopardy due to death, disability, or retirement.

To protect themselves and their businesses from failure, many business owners have turned to buy-sell agreements as a solution. A buy-sell agreement is a legally binding contract between co-owners that determines the course of action if a co-owner chooses or is forced to leave a business, and the process of governing or purchasing that person's share. The Piedmont Group wanted to discuss and explore this pressing issue, and so we consulted with financial advisor Casey Bradley. He outlined the basics of a buy-sell agreement, and the six important questions to ask before you decide to create one of your own.

1. How could I benefit from a buy-sell agreement?

Every business owner will exit their business at some point in the future, whether it be voluntary or involuntary. However, only 46% of business owners have a buy-sell agreement in place. That's an alarming number.⁠3

In many cases, the business owner's largest and most important asset is the business itself. If something were to happen to one of the primary owners, it is important to ask how that will effect the lifestyle and exit plans of the surviving beneficiary, other owners, and the business. Are you prepared to run a business with the surviving beneficiary in the event something happens to your partner? Are you willing to share your business with your deceased partner's beneficiary?

This is where buy-sell agreements come in - they can take the guesswork out of the future of your business.

2. What is a "triggering event"?

A "triggering event" in a buy-sell agreement is when a primary owner becomes disabled or dies. Ideally, buy-sell agreements will include a clause about what happens in the event of a primary owner's death. However, including a clause about what happens if a primary owner becomes disabled can be just as important.

How would the incapacitation of a primary owner affect the sales, value, and growth of the business? What would be the consequence if that owner never returned to the business?

3. How is the agreement funded?

Buy-sell agreements, when exercised, are funded from the business. There are several ways to accomplish this, but often times the one of the most cost-efficient way is leveraging an insurance policy.

Still, only 35% of buy-sell agreements are funded with life insurance⁠4. This means that in the case of an owner's death or disability, a majority of companies must buy that owner's shares with funds from the business bank account. If both owners are protected with life and disability income insurance, however, the business may not be required to foot the bill. This is why the funding method of a buy-sell agreement can be crucial in the event of a death or disability, as an insurance policy places the risk on an insurance company rather than the business.

4. Do you need a valuation of the business?

A valuation⁠5 of the business when discussing a buy-sell can be vital. Valuations can help you know what your business is worth, and can determine the path of action that you can take after a triggering event occurs. If there is no stipulation in a buy-sell agreement that requires an updated valuation of the company, the surviving owner may be required to pay the amount stated in the original agreement, even if that amount is no longer true to the company's actual worth.

Similarly, the valuation of a company may be different after a primary owner leaves a business. It can be important to know how your company's value depends on its current organizational structure.

5. Is the agreement personally guaranteed?

If the business fails due to the death of a primary owner, it's important to know if the surviving owners are liable for paying the surviving beneficiaries based on the original amount agreed upon. Understanding whether or not an agreement is personally guaranteed will ensure that you are educated on your risk should the business shut down.

6. Who can you ask to help with your buy-sell agreement?

Consulting with a trusted attorney can be crucial to having a proper buy-sell agreement in place. Because buy-sell agreements can be difficult to discuss with a business partner, and complex to organize and implement, an attorney can act as a guide and a mediator for those tough conversations. Discovering each business partner's wants and needs with the use of an attorney can be more effective than attempting to do so on your own.

It can be hard to plan for something that you may not foresee anytime soon. However, death, disability, and retirement are eventualities that are best managed before they become a present reality. Buy-sell agreements can be tailored to fit those realities, and along with competent legal and tax advice, can be an effective way to ensure the life of your business after you leave it. Specifying if and how business owners interests may be distributed, transferred, or shared can also be essential to preventing conflict between partners, family members, and other beneficiaries.

Many more factors can contribute to whether or not a buy-sell agreement is best for you and your business partners. If you're interested in learning more about a buy-sell agreement and if it may be fit for your company, contact us and speak to an advisor now.

1 https://www.wilmingtontrust.com/repositories/wtc_sitecontent/PDF/The-Power-of-Planning.pdf

2 https://www.experian.com/whitepapers/BOLStudy_Experian.pdf

3 Exit Planning Institute, State of Owner Readiness Survey, 2018 MassMutual Business Owner Perspectives Study, 2018

4 Source: MassMutual Business Owner Perspectives Study, 2018

5 The Piedmont Group does not provide qualified business valuations. For a qualified or certified business valuation, consult a properly credentialed appraiser.

Contact Us

Supervisory Office:

1050 Crown Pointe Parkway Suite 1800
Atlanta, GA 30338

Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services, LLC, Member SIPC. Visit SIPC. The Piedmont Group does not provide legal or tax advice. Consult your own personal attorney, legal, or tax consultant for advice on specific legal and tax matters.