Business Continuation

There are a lot of “what if’s” in a business partnership

In Sheila and Kendra’s case, tragedy came in the form of the death of a business owner. What would have happened if Sheila had survived the car accident, but was so disabled that she could no longer work? Or what if Kendra had to move out of state due to family responsibilities, and therefore needed to exit the business? What if Sheila divorced and, because they lived in a “community property” state, was forced to pay her soon-to-be-ex for 25% of the business (i.e. half of Sheila’s 50% interest in the business). And so forth.

In the world of business partnerships, unforeseen circumstances can cast a shadow over even the most successful ventures.

A Buy-Sell Agreement can address the “what if’s”

A Buy-Sell Agreement is a crucial but often overlooked aspect of partnership planning. Also known as a “business will,” a Buy-Sell Agreement is a legally binding contract between business partners. It addresses vital financial aspects of partnership continuity, including:

• Ownership transfer – A Buy-Sell Agreement provides for a smooth transition in the event of a partner’s exit, thereby minimizing disruption to the business’ operations. In the event of a partner’s death, disability, divorce, retirement or other triggering events, the Buy-Sell Agreement outlines how that person’s ownership interest will be transferred. If there’s a divorce, is the divorcing partner required to buy out his or her spouse? Is that spouse required to sell? In the case of debilitating disability, is the disabled person required to sell? If not, how will the other person be compensated for the fact that the disabled person is no longer doing their share of the work? What if the disability is just temporary? If one partner wants to retire and the other does not, how will that be handled? If both partners want to retire, what is the succession plan? If one partner dies, will the remaining partner have the right to buy out the deceased partner’s heirs – even if these heirs have a desire to join the business? A Buy-Sell Agreement can address ownership transfer in all of these “what if” scenarios and more. In this way the Agreement can ensure that the surviving partner retains control of the business and everything is done in an equitable manner.
• Fair valuation – All of these “someone buys out the other person’s interest” or “we sell the business” situations require an agreement as to what the business is worth. A Buy-Sell Agreement defines a fair and predetermined valuation method for determining this. Agreeing on this in advance prevents disputes about the business’ worth and ensures a fair process that benefits all parties involved.
• Sale to a third party – In cases where the remaining partner will not be purchasing the ownership interest, a Buy-Sell Agreement can provide a framework for a third-party sale.
• Protection for heirs – A Buy-Sell Agreement can ensure that if a partner dies and their heirs will not be participating in the business, these heirs receive fair compensation for their loved one’s ownership interest.

Life insurance can be used to fund a Buy-Sell Agreement

A Buy-Sell Agreement must also establish funding mechanisms to facilitate the transfer of ownership. Where will the money come from? If you don’t address this issue, you can end up in a situation where it is not financially possible to implement the plans that everyone had agreed upon.

Quite often the answer to the funding dilemma is life insurance.

Life insurance is a common tool used to provide the necessary funds to buy out a partner’s share in the business. In this case you need to be sure to purchase a policy that will provide enough funds (in the case of a partner’s death) or cash value (for situations such as disability or divorce) to cover the anticipated financial needs.