Buy-Sell Agreements: A Critical Business Estate Planning Tool
By: Lisa Manzolillo, CFP®, CDFA®
Nobody likes to think about their own mortality. But if you own a business, it’s your responsibility to do just this by planning ahead for how your business would continue if you unexpectedly died or became disabled.
Making contingency plans for these scenarios is a critical aspect of succession planning. One of the most effective tools for this kind of planning is a buy-sell agreement. This is a formal legal document that helps ensure the smooth transfer of your business to your partners or beneficiaries should you die or become disabled.
Orderly Transfer of Business Interest
A buy-sell agreement can help you be more confident that ownership and control of your business interest will be transferred in an orderly fashion to your surviving partners, key employees, or an outside buyer. It can assist with removing any guesswork for all parties with a potential interest in the business’ succession, including:
- Your partners, who can retain control and ownership of the business without worrying about a surviving spouse becoming an unwitting partner.
- Your employees, who can feel better about the long-term prospects of the company in the event that something happens to you.
- Your family, who will be assured that they’ll receive compensation for your ownership interest at a price that’s agreed upon ahead of time.
Without a buy-sell agreement, there could be conflicts and even litigation between your surviving partners and family members. It’s not uncommon for individuals to end up becoming partners in their deceased spouse’s business even if they have little interest or knowledge of the business or desire to help run it.
Funding of a Buy-Sell Agreement
Buy-sell agreements are typically funded using cash value life insurance or a disability buyout policy. They are also sometimes funded using a “sinking fund” in which partners agree to set aside money voluntarily to buy the shares of a deceased or disabled partner. Or surviving partners can simply borrow the money to buy the shares.
There are two types of buy-sell agreements funded using life insurance:
- Cross-purchase agreement — This works best when there are just two or three partners, each of whom purchases a cash-value life insurance policy on every other partner. If any one of them dies, the others would use the life insurance proceeds to buy his or her business shares.
- Entity purchase agreement — This works best when there are more than three partners. Instead of partners buying life insurance policies on each other, the business entity buys policies on each partner. If any one of them dies, the shares would be bought by the business and divided among the surviving partners.
Valuing the Business
It’s critical for all partners to agree on a binding value for the business before the buy-sell agreement is structured. The best way to do this is to hire a valuation professional to perform a formal business valuation before the agreement is drafted. This valuation may need to be updated periodically as things change.
Once it’s drafted, partners and beneficiaries should review the buy-sell agreement periodically and make any adjustments that might be needed. The agreement should be structured so that it’s flexible enough to accommodate everyone’s changing circumstances over time.
Keep in mind that a poorly drafted buy-sell agreement can be worse than no agreement at all. So, it’s usually smart to work with an estate planning attorney who specializes in business succession planning as you draft your buy-sell agreement.
How A Financial Advisor Can Help
A Simon Quick advisor can answer your questions about buy-sell agreements and help you and your partners structure an agreement for your business. To learn more, call us at (973) 525-1000 or send an email to info@simonquickadvisors.com.
About Lisa Manzolillo
Ms. Manzolillo joined Simon Quick in 2018 with over 13 years of experience in wealth management and investing. As a Client Advisor based in Morristown, NJ, she works with clients to identify and implement custom-tailored investment management and financial planning strategies designed to help each client achieve their unique financial goals and objectives. Ms. Manzolillo has experience working in all areas of financial planning, including retirement planning, estate planning, tax planning and risk management. Ms. Manzolillo graduated summa cum laude from University of Rhode Island with a BS in Accounting and earned an MBA with a finance concentration from Fordham University. She completed her Financial Planning Certificate Program at Pace University and became a CERTIFIED FINACIAL PLANNER™ practitioner in January 2008. In 2017, Ms. Manzolillo became a Certified Divorce Financial Analyst (CDFA). To learn more about Lisa visit her LinkedIn.
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