These agreements spell out exactly how the business will continue to operate if an owner leaves the business.
A client recently asked me about ways to safeguard her business’s future.
She’s in business with two partners, and although everything is going great right now, they want to make sure it stays that way if one of them wants to leave the business or can no longer participate, maybe because of illness or if they die.
These owners are putting their lives into this business and they want to have a plan, rather than just hoping for the best when the worst happens.
I recommended that we look at a buy/sell agreement for her and her business partners. These agreements are advance plans that answer questions about what will happen if one owner leaves the business. They spell out how the business will continue, who will fill the departing owner’s role, and who will own the former owner’s share of the company.
To find out more about how these agreements protect business owners’ hard work, I talked with Jennifer Black, senior financial adviser at Dedicated Financial Solutions, Mississauga, Ont. She is co-author of Managing Alone: Your Trusted Advisors’ Guide to Surviving the Death of Your Spouse.
According to Black, it’s critical for business owners to know what their options are if one of them dies or leaves the company for another reason, and this means it’s imperative to have an agreement in place before the need arises.
“A buy/sell agreement formalizes, in advance, the decisions of the owners about the best course of action if one of them leaves the business. It covers what happens with business ownership if an owner dies, retires, or leaves the business for any other reason. Planning is the best way to overcome uncertainty about the loss of a business owner,” explained Black. “By planning for various possibilities in advance, the partners have the opportunity to agree on what they will do if the situation arises.”
Essentially, the remaining owners have four choices:1. Wrap up the business.
What is included in any buy/sell agreement depends on the circumstances, said Black; however, most include:- The circumstances or events that trigger a buy/sell transaction.
Typically, the remaining owners wish to buy out the departing owners, but what is the best way to ensure this happens?
“I usually recommend that business owners have insurance to cover the cost of buying the former owner’s shares, if that’s the plan,” said Black. “It’s critical to have that funding for the share purchase in place. Without it, the remaining owners may not be able to afford to buy the shares, or they may have to compromise the business’s finances to do so. Owners can try to set money aside or they may be able to borrow the funds or sell some assets, but the most secure way to ensure they can fund any buy/sell obligations is to buy life and disability insurance to cover it. Insurance is the most affordable way to guarantee the money will be there if needed.”
Deciding on who owns the policy, again, really depends on the business’s circumstances. Owners thinking about developing a buy/sell agreement should talk with their various business advisers. But it usually makes the most sense for the company to own the insurance policy -- and pay the premiums -- or for individual shareholders to own policies on each other. They also need to remember to plan for the business’s growth too. Insurance products provide coverage that grows with the business for protection now and in the future.
Formalizing ownership transition decisions with the other owners through a buy/sell agreement really is one of the best ways owners can secure some peace of mind about what will happen to the business they have built if they are no longer part of it.