If you own a business, it is important to consider the future of the business as much as the present.
Succession planning is part of that process. Succession planning for your business is often covered in what is commonly called a buy-sell agreement.
In a buy-sell agreement business owners agree how their interests in the business will be dealt with upon a trigger event for the example the death of one owner.
Buy-sell agreements are also often referred to as ‘business wills’, and they can be used together with or incorporated in a partnership agreement, unitholders agreement or shareholders agreement.
This article will look at how buy-sell agreements operate, and the benefits of incorporating one in a business succession plan.
Buy-Sell Agreements – An Overview
Essentially, a buy-sell agreement is an agreement between the co-owners of a business. It gives:
- A co-owner who is leaving the business the option to sell their interest in the business to a co-owner who is staying on for a pre agreed price when a specified trigger event occurs. This is known as a put/sell option; and
- An option for a co-owner who is staying in the business to purchase a leaving co-owner’s interest in the business for a pre agreed price when a specified trigger event occurs. This is known as a call/buy option.
What is a trigger event?
A trigger event refers to a particular situation that prompts a sale as outlined in the buy-sell agreement. Trigger events are generally involuntary events such as death or total and permanent disability. Trigger events can also include critical or terminal illnesses, and trauma.
How are buy-sell agreements funded?
A buy-sell agreement will have a mechanism for valuing a seller’s interest in the business. The common ways of doing this is to have an agreed price which is reviewed on an annual basis or a formula for working out a price.
Depending on the value of the business the funding of the purchase is often done through life insurance policies. The co-owners take out insurance policies for the relevant trigger events. The insurance covers each co-owner’s respective interest, and is reviewed and updated annually. If a trigger event is activated, the remaining co-owners will apply to the insurance company for a payout on the outgoing co-owner’s insurance policy. This payout will then go to paying for the purchase of the interest by the continuing co-owner/s.
Why Should I Have a Buy-Sell Agreement?
There are several benefits in having a buy-sell agreement in place. Some of these benefits include:
- It minimises the risk of uncertainty on how the business will continue in the event of an unforeseen situation.
- Allows a co-owner to continue the business in the business if there is a trigger event. The continuing co-owner will have pre-existing knowledge of the business and the way in which it functions, and therefore can act to maximise the interests of the business as a whole.
- Reduces the risk of ownership disputes if there is a trigger event.
- Provides the outgoing co-owner or their estate with financial compensation for selling its interest in the business.
- Where a trigger event does occur, the continuing co-owner can focus on maximising the interests of the business rather than worrying about the future of the business. This is more productive than spending time and effort to determine how to purchase the outgoing co-owner’s share in the business or prevent a third party from doing so.
- Consider including a buy-sell agreement as part of your business succession plan, as this can reduce the stress and uncertainty caused by an unforeseen event such as the death of a co-owner.
- The risk of disputes stemming from who should acquire the outgoing co-owner’s interest is significantly reduced.
If you are entering into a business transaction and have any questions, or require a specialist commercial or business lawyer you can contact Lord Commercial Lawyers on 9600 0162 or email us at email@example.com the form on this page.