According to The Complete Guide To Business Brokerage By Tom West, the number of small to mid-sized, privately owned businesses for sale in the United States is estimated to be approximately 1 million – or 20% of them at any given time. But only a small number of them get sold:
- 1 in 5 small businesses sell
- 1 in 4 small to mid size businesses sell
- 1 in 3.5 mid-size companies sell
- 1 in 3 large companies sell
There may be no ready buyers for your business, and you may lose your most hard earned asset. Consider this example.
- Do you have the right or the obligation to buy them out?
- If so, for how much and on what terms?
- Can you strike out on your own, or are you stuck with the baggage of the old one?
What if you die instead of your partner?
- Will your partner pay your family a fair price for your share of the business?
- Will he just walk away and start up a new business on his own?
The 3 Problems of Business Continuation
1. No buyers offering a fair price – There may not be a ready market for your business in even the best of economic times, and unforseen events like death or sickness can force a fire sale. You may work hard all your life to build a business, but have nothing to leave your family.
2. Forced Partnership with a spouse or child – If you don’t have the cash to buy out your partner’s interest, you may find yourself in business with a spouse or child who may actually be a drag on the profits and viability of your business.
3. Can you leave a family legacy? – If you die before your partner, what assurance do you have that your surviving partner will pay your family a fair price for your share of the business?
Without it, a closely held or family business faces a world of financial and tax problems on an owner’s death, incapacitation, divorce, bankruptcy, sale or retirement…A buy-sell agreement can ward off infighting by family members, co-owners and spouses, keep the business afloat so its goodwill and customer base remain intact, and avoid liquidity problems that often arise on these major events.
Creating a Market for Your Business
Business-succession specialists and financial planners often recommend an insured buy-sell agreement to ensure that your family can receive a fair value for the business you worked so hard to build, and allow you to buy out your partner’s share and continue the business as a going concern. It does two things:
- It creates an immediate market for your business (your partner or a successor employee.)
- It can create immediate funds for a fairly valued buyout through insurance.
The 5 Guarantees of A Properly Structured Agreement
A properly-structured agreement will guarantee the following:
- guaranteed purchaser
- guaranteed sale
- guaranteed price
- guaranteed time
- guaranteed funding
1. Guaranteed Purchaser
Who will buy?
- the surviving partners must buy
2. Guaranteed Sale
Who will sell?
- the estate of the deceased partner must sell
3. Guaranteed Price
What is the price?
- have a formula or outside valuation
4. Guaranteed Time
When to transact?
- automatically at time of
5. Guaranteed Funding
How to pay?
- selling personal assets
- borrowing from a bank
- paying in installments
- using a life insurance death benefit (see Corporate Uses of Life Insurance)
Implementing A Simple and Cost Effective Solution
Cross Purchase vs. Redemption: One type of agreement is a cross-purchase: If you or your partner/successor dies, becomes disabled, goes bankrupt, etc., the other can buy his share. With a redemption style agreement, the business itself would make the purchase so the owners don’t individually go out of pocket.
With either type of buy-sell, there’s lots of flexibility. The price might be fixed, determined by appraisal or formula. The price might be paid in cash or installments over time. There can be different terms for different events, one price and terms for retirement, one for disability, one for death.
Insurance: Insurance features prominently in many buy-sell agreements. You don’t have to use insurance, but it can ensure there’s cash available when the time comes. For example, whether you or your partner/successor dies first, a life insurance policy on each of you can fund the buyout so your business stays afloat and the spouse/heirs are bought out as agreed. A buy-sell agreement is funded with life insurance on the participating owners’ lives can guarantee that there will be money when the buy–sell event is triggered. Using insurance to fund the buy/sell agreement has these advantages
- funds are available when needed
- least expensive solution
- new owner does not incur debt when buying the business
Reciprocal Planning: While you may find it difficult to face these issues and to make some of the decisions, any buy-sell agreement is better than none. The best thing about buy-sell agreements are that they are reciprocal. No one knows for sure if you or your partner will be the first to go by death, disability, retirement, or for other reasons, and this reciprocal nature makes negotiating and agreeing on these issues easier to do.
How to Get Started
You’ll need a business or tax lawyer experienced in buy-sell agreements to draft it. However, these agreements can be surprisingly simple and cost effective. Whatever you pay for it and the insurance premiums on an insured arrangement will be small in comparison to what it can save you.
One of the best starting points is a financial planner or insurance specialist. They may have prototype documents to recommend to your attorney, but, more important, they may have invaluable experience and can give you guidance in thinking out the key decisions before you meet with an attorney to get it done, which will save you time and money.
- Making the Breakup Much Easier
- The Eight D’s of Buy-Sell Agreements
- Buy/Sell Agreement Checklist
- Sample Buy/Sell Agreement