Buy-Sell Agreements can be an important tool for any business that has more than one owner. Buy-Sell Agreements are traditionally structured around “The 4 Ds”. The legal document defining the Buy-Sell Agreement is designed to protect the company in the case of Death, Disability, Disagreement (between owners) or Divorce.
In the case of the untimely death of an owner, the Buy-Sell Agreement sets the terms by which the surviving spouse can be bought out by the company or the remaining owner(s). Stock will typically be sold from the deceased’s family to the remaining partners in exchange for cash. In an appropriately funded buy-sell agreement, each owner’s life will be insured by the company so that there is ready cash on hand for the transaction at the time of death.
To address disability, the legal document will describe what actions would be taken if an owner was not able to perform their job duties. There are a number of options but one example would be buying out the disabled owner if they cannot be an active contributor to the company. Disability insurance is typically the vehicle the businesses owners would purchase ahead of time to allow the disabled owner to get income in exchange for shares of the company. However, today there are types of life insurance that will pay if one has a disability, long term care event or even cancer and other major illnesses. This can be very valuable because the owners only have to buy one insurance policy which can be more affordable and it can cover many contingencies.
The disagreement clauses of a Buy-Sell agreement are designed to settle terms in the case of irreconcilable differences between owners. The courtroom is a very expensive place to sort out the process. The terms of the agreement act as a “pre-nup” for business partners.
The last of the 4 Ds is the marital divorce of one of the owners where a former spouse may garner a portion of the company through the divorce agreement. The divorce clauses of the Buy-Sell agreement can protect the owners from the prospect of an unexpected new minority owner and in doing so still provide financial benefits to the former-spouse.
While the majority of small businesses could benefit from a well-crafted and well-funded Buy-Sell Agreement, only a small portion have them. To understand how Buy-Sell Agreements could play a role in your Business Planning, contact a Trilogy Advisor.