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How do buy-sell agreements work?

Buy-sell agreements can help protect businesses from sudden emergencies. Certified financial planner Patrick J. Cloonan Jr. explains how such agreements work.

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Frank Eltman/AP/File
P.J. Whelan, the owner of Lindell Delicatessen in Long Beach, N.Y., prepares a sandwich in his establishment on Monday, April 21, 2014. Buy-sell agreements can help protect businesses from sudden emergencies.

Sudden events can cripple a small business. One way to protect the business from such an event involving one of the owners is a tool called a buy-sell agreement.  A properly constructed buy-sell agreement allows the business to continue operations should something catastrophic happen to the owner, or even if the owner decides to retire.  Let’s discuss an example:

I am one of three unrelated owners of a small business shared equally, and I pass away.  My heirs would like to get full value for my share of the business, but the business does not have the cash flow to buy out my portion of the business.  My spouse becomes a one-third owner of the company with no knowledge of how to run the business and has no interest in the business. This results in a dispute between my spouse and the remaining owners of the business, leading to a forced sale of the business. Because it was forced to sell, the business was not sold for full value.

So, what is a buy-sell agreement?

A buy-sell agreement is a legal contract that provides funding for the future sale of your business interest when an event is triggered. Death is not the only trigger—indeed, events that can trigger a buy-sell agreement include long-term disability, retirement and divorce. The buy-sell agreement immediately provides a buyer’s interest, and sets the triggers that can prompt a change in ownership.  The buyers can be other people, or an entity, and there can be more than one buyer.

What kind of buy-sell agreements are available?

There are quite a few available, and the best plan will depend on your situation. The nature of your business, the structure of the business, participation within the business, the number of owners and the relationships within the business all are factors that will help you determine the appropriate buy-sell agreement. However, the best recommendation would be to get professional help from an attorney, tax advisor or your financial planner.

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