Courtesy of Kareim M. Abbouda from Investors Group.
Is your business prepared for an unexpected ownership change?
A buy-sell agreement can help avoid future turmoil.
Your business couldn’t be better – and then it happens: a co-owner suddenly becomes disabled or dies from illness or accident. That could mean the disruption of your business, your income and possibly even a comfortable retirement.
That is why business succession planning – including a well-constructed buy-sell agreement – makes good business sense, for both co-owners of a partnership or a corporation. Using a sports analogy – in any sporting event, if there’s a conflict, it’s resolved by going to the rule book. Think of a buy-sell agreement as a rule book for resolving conflicts and other issues in your business. The difference is that, in business, co-owners themselves mutually agree on how the game will be played by writing the rules in advance and in anticipation of certain events, particular needs and desires.
Buy-sell agreements – sometimes included as part of shareholder agreements – can provide clear ‘rules’ for succession upon death or some other triggering events, and benefit the interests
of all shareholders. Such an agreement can play an important role in the preservation of a business and in providing financial security for the business owners and their families.
You and your co-owner(s) establish the rules by creating and entering into a buy-sell agreement that sets out firm commitments and obligations for buyer and seller and their respective heirs. A properly drafted agreement will set out provisions for triggering events, such as:
• The death of a co-owner,
• The disability of a co-owner,
• The desired sale of shares to a third party,
• Loss of a professional’s credentials,
• Termination of employment of a co-owner,
• Bankruptcy of a co-owner, or
• A falling out between co-owners.
A properly funded buy-sell agreement can help to avoid finding yourself in business with someone not of your choosing or being forced to post a ‘For Sale’ sign.
For the fund of it
No doubt, you plan for the value of your business to increase over time, making a potential future buy-out even more costly. If one party dies or becomes disabled, where does the surviving/healthy co-owner(s) get the money to acquire that party’s share of the business?
You can use your own money if you have the liquidity. Or, you can sell off other assets, but in most cases these assets will not bring full value in a forced sale situation, so these are usually not attractive options.
You can borrow the money, but given that the principal must be paid back with after tax dollars and is not deductible, that’s not usually considered an optimal solution either.
The most attractive option is usually an insurance policy, a relatively inexpensive way to help fund the buy-sell agreement. This option guarantees cash in a lump sum at exactly the time when it is needed to be used by the surviving or healthy co-owner(s) to purchase the business interest from the disabled co-owner or the deceased co-owner’s estate.
A buy-sell agreement, paid for by insurance, creates liquidity for the business interest, and reduces or eliminates loss of business value that can occur as a result of a forced liquidation or failure in the aftermath of an owner’s death or long-term disability.
It can also remove the risk of friction between the surviving owner(s) and the deceased owner’s heirs, and stabilize the ongoing operation of the business – the buyer is free to operate the business without the need to share decision-making or profits with inexperienced heirs. The buy-sell agreement may also be structured to provide life insurance proceeds to reduce business debt and offset expected reductions in sales revenue due to the death of a co-owner who is a key person in the business operation.
Businesses must plan ahead to avoid disaster. Talk with a professional today concerning effective insurance coverage in order to reduce or eliminate financial risk and confusion about a change of business ownership. Working together, we can customize a plan to fit your needs.
For more information on related topics, please contact DFS Private Wealth, the author of Managing Alone and founder of widowed.ca. We are here to help and answer any questions you have. Should you need a connection to a professional in your area we would be happy to make the introduction for you to someone you can trust. Contact Us today..
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