Picture this: You and your partner are equal owners in a small business that you’ve both built from the ground up. You have a strong working relationship founded on trust. As a result, the business is a success and you wouldn’t dream of doing anything else. Your families share a close friendship. You’d do anything for them and they’d do the same for you.
Then one day, unexpectedly, your partner dies and is no longer in the picture.
Losing Control Over Your Business
This is a situation, unfortunately, that is all too common. Many businesses faced with this challenge have collapsed under its weight. Perhaps it was because the partner’s family needed to pay estate taxes and they looked to the surviving partner — you — for cash equal to the amount of their share of the company. That could mean forced sale or liquidation. Or, maybe the partner’s spouse, or other family members — who now own half of the business — want to be the “boss.” However, you can take action to make yourself less vulnerable and more in control of the future of your business.
Planning Ahead with a Buy-Sell Agreement
Instead of being in a position where you could potentially have to share, or cede, control of your business, you can put in place a plan that can help ensure that the business continues, the deceased partner’s estate has the funds necessary to help meet their obligations, and that full ownership passes seamlessly to the surviving partner. This plan is called a buy-sell agreement. It is also referred to as a buyout agreement.
A buy-sell agreement is a legal document that spells out what happens to the business if one partner dies, becomes disabled or retires. This foundational agreement typically details the current value of the business (to help determine the price of the buyout), identifies who a partner can, and cannot, sell their ownership shares to, describes tax effects of a buyout, and specifies the procedures and steps that must be taken in the event of a buyout.
Your professional advisors can guide you in how to properly set up a buy-sell agreement for your partnership.
Funding a Buy-Sell Agreement
Buy-sell agreements are an important part of your overall succession planning process. And like all components of an effective succession plan, the funding of the buyout should be specified in the agreement. One common approach to funding a buy-sell agreement is through life insurance. In this case, each owner (or the business) purchases life insurance policies on the other partner, and in the event of death, the proceeds are used to purchase the ownership share from the deceased partner’s estate. This creates a "clean break" for all involved and can help minimize disagreements between parties. The estate gets their share of the value of the company, and the surviving partner gets full ownership.
Buy-sell agreements are an important part of any partnership. You, your family, your partner and their family, your employees, and your community need to know that, should the unexpected occur, a smooth transition of ownership will take place. After all, it’s worth protecting all that you and your business partner have worked so hard together to build.