A buy-sell agreement could have helped a recent business client avoid a lot of problems.

Let’s call my client Max. Max’s business partner owned half the business. The partner died, leaving behind a wife and two adult children.

Max had always gotten along with his partner’s family. But he never had any business discussions with them.  A few months after the funeral his partner’s wife called asking questions about the business. His partner’s children also called asking questions. They all claimed to be co-owners of the business according to his partner’s estate plan. They either wanted money to buy out their shares or they wanted to make important decisions about the company’s future.

“I don’t have the money to buy their shares in the business” Max said “so, am I really in business with my partner’s family now?” The answer was difficult to take. Without the money on hand to buy out the shares, Max was indeed in business with his partner’s family. Max wasn’t happy.

That leaves us with two questions. What are Max’s options now, and how could he have avoided this mess?

What Is a Buy-Sell Agreement?

One of the most crucial documents for a business owner in business with others is a Buy-Sell Agreement.  A Buy-Sell Agreement is a legally binding agreement that governs what happens when a partner or owner of a business either dies, becomes disabled, is forced to leave the business or chooses to leave the business.

A buy-sell agreement can provide liquidity for dealing with these major events in a business. It also helps to avoid infighting among family members, co-owners, and spouses.

For Max, having a buy-sell agreement could have answered the following questions after his partner died:

  • Is my new co-owner my deceased partner’s wife and kids?
  • Do I have to buy them out?
  • If I have to buy them out, what amount do I need to pay them?
  • If I need to buy them out, where does the money come from?
  • Can they sell their interests in the business to my competitors if they need money?
  • Can I start a new business or do I have to stick with the old one?

How Does a Buy-Sell Agreement Work?

A buy-sell agreement legally binds the people who sign it, and their heirs as well.  That means that any co-owners wives, children, and other beneficiaries are also bound by the terms of the agreement.  The agreement can also establish a manner of valuing the business for buy-out and purchase purposes, so there are no disputes as to how much money needs to change hands.

How is a Buy-Sell Agreement Funded?

A life insurance policy is generally used to fund a buy-sell agreement.  When someone dies, insurance money flows into the business. The money is used to purchase the business interests from the heirs of the deceased co-owner. It also provides enough money to stay afloat during the transition.  Finally, it ensures that the business interests stay in-house and the original owners can control who they are in business with.

Are There Any Options?

There are many different types of buy-sell agreements. They can address many issues such as disability and retirement, beyond just the death of an owner.  An estate planning and business attorney experienced in drafting buy-sell agreements can help you choose and draft the right type of agreement for you.

Who Needs a Buy-Sell Agreement?

For any business owner in business with others, an updated buy-sell agreement is an absolute must have.  Just like many other legal issues in business, if you prepare in advance, you are better off when something unforeseen happens.  If protection for your business and family is important to you, act now before it is too late.

Written by Brian G. Quinn, Attorney with Quinn Estate & Elder Law