Many businesses, especially partnerships and corporations with a small number of shareholders, use contractual arrangements to control what happens if one owner dies or for any other reason the owners wish to go separate ways. These arrangements are called “buy-sell agreements.” If your business has multiple owners, you may want to consult an attorney and have an agreement drafted.
A buy-sell agreement can be used to prevent disruption by:
- Providing for the stable continuance of the business.
- Establishing a valuation process.
- Helping to solve estate-planning issues for the owners.
Continuance of the business
When a major owner of a business dies, becomes disabled or retires, having a plan in place is important. A buy-sell agreement can lay the groundwork for the remaining owner(s) to buy the departing owner’s interest, for the business (if a corporation) to buy back the ownership, or for the ownership to be sold outright.
Most small businesses are hard to value. Without the presence of a major owner, valuation can be even more difficult. Many buy-sell agreements stipulate some form of valuation model as part of the process of passing ownership. It may be a flat dollar value model, some multiple of earnings or cash flow, or some other formula driven method. Buy-sell agreements can also be drafted to create a situation where the value is based on what one owner is willing to pay the other owner for his or her interest.
Estate planning issues
Many business owners face difficulty in creating effective estate plans. Some of the most difficult issues are:
- What happens to the owner’s interest in the business?
- How should the interest be valued for estate tax purposes?
- Will there be funds available to pay any estate taxes that may be due?
A buy-sell agreement can set the rules for the transfer of interest in the business. If the agreement stipulates a valuation method, that method may become the basis for valuing the business for estate purposes. The IRS doesn’t have to accept the valuation method, but often does if the method is reasonable. Finally, if there is a sale process set out in the buy-sell agreement, that process could include the new owner paying for the interest and any estate tax that may be due.
Prepare for the unexpected
If your business has multiple owners, you should probably have some form of contractual buy-sell agreement in place. Being prepared for the unexpected is good business. The process of creating the agreement will also probably result in the owners having frank discussions about the future of the enterprise — and that too is good business.
This news is provided as a service to you by Marlin Business Services Corp., a nationwide leader in commercial lending solutions for the U.S. small business sector. Marlin’s equipment financing and loan programs are available directly and through third-party vendor programs, including manufacturers, distributors, independent dealers and brokers, to deliver financing and working capital that help build your success.