Buy-Sell Agreements and Business Insurance After the Loss of a Partner
Buy-sell agreements and business insurance after the loss of a partner will protect the business from extra turmoil after such a loss. A partner or major stakeholder's death or incapacity is going to be a major shock to a company. Imagine how much worse it could be if that person's stock or ownership stake were to pass to a distant relation through probate or if the estate were to tie up control of the company for months or years. An effective buy-sell agreement can prevent this by creating a contract for the business to buy the stake of an owner after death, retirement, or incapacity. An experienced business attorney can help you create a valid and effective buy-sell agreement to protect your company.
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UPDATED: Feb 3, 2021
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- Buy-sell agreements are tools that can be used in case of the death or disability of a key figure in a business.
- When a key person dies, is incapacitated, or retires, a buy-sell agreement can ensure that any stock or ownership stake transfers according to that person’s and the business’s interests.
- Without buy-sell agreements, ownership rights or control of a company may pass through inheritance or other means that would be detrimental to the operations of the business.
Nothing can be more devastating to a business than unexpectedly losing a key contributor due to death or disability. One way a business can minimize the damage from losing a partner is through a common business law instrument called a buy-sell agreement.
Basically, a buy-sell agreement is a contract between the company and the individual that creates an obligation of the individual (or their estate) and the company. If the triggering event occurs — whether that’s retirement, death, or long-term disability — the stakeholding individual agrees to sell some or all of their stock or control and the company agrees to buy.
Sometimes called buy-sell agreement life insurance, business insurance, or business life insurance; these agreements are designed to insure the business can continue after a major loss.
Understanding how to use these buy-sell agreements and having yours reviewed by an expert attorney knowledgeable of these types of contracts is the best way to get the best results from these documents. You can use your ZIP code to search for an experienced business law attorney near you to get help on protecting your business with a buy-sell agreement or other important instruments.
What is a Buy-Sell Agreement?
A buy-sell agreement is a legal document that binds business partners to buy out the interest of a deceased partner at terms and prices that are predetermined so as to allow the business to continue to be run by the remaining partners. Most businesses use key person business insurance to fund the buyout of the deceased partner’s share. The business will pay the premiums and the death benefit is used to fund the buy-sell agreement transaction.
It is important that any buy-sell agreement be carefully drafted by attorneys experienced in how to meet the exact requirements of the organization.
If you are prepared to write a contract without an attorney, there are buy-sell agreement templates that you can use, but make sure that you do not underestimate the need for a business attorney that can review your agreement for any legal problems that could arise.
Similar arrangements may protect against long term disabilities. An unexpected disability can sideline a main player in a business. A buy-sell agreement funded by a disability policy can provide needed funds in the event of such an incident and buy out the interests of someone who will not be able to return to the business for a long period of time. Disability income protection can also contribute to paying overhead expenses when an owner is incapacitated.
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Buy-Sell Agreements in Closely Held Corporations
The death of a shareholder of a closely held corporation does not terminate the corporation, but it may have serious consequences concerning the continuation of the business and the disposition of the deceased shareholder’s stock (including the possibility of unwanted heirs or outsiders acquiring the stock and becoming involved in the business).
The sale of the deceased owner’s stock could become effective immediately upon death. Again, the solution here could be a properly designed and executed buy-sell agreement. The buy-sell agreement should reflect the goals of the people making the agreement clearly and in great detail. Some agreements require the other shareholders to purchase the stock of the deceased shareholder at the time of death. For closely held corporations where stock is an issue, you could also design a stock redemption plan.
What Is a Stock Redemption Plan?
A stock redemption plan effectively is a buy-sell agreement that stipulates the cash sale of the stock of a deceased shareholder or owner. The corporation buys and redeems (holding as treasury shares) the shares of the deceased shareholder. A shareholder may wish to receive cash for his or her stock in a closely held corporation in order to retire or for other reasons. In this case, cash value life insurance can be used to fund a buy/sell agreement to be carried out at the time of retirement of an owner.
A similar situation can arise when an extended period of disability renders an owner unable to continue with the business and thus trigger an agreement to redeem the stock of the affected stockholder. Buy-sell agreement plans for contingencies such as this can be established with funding coming from disability insurance or life insurance policies.
Determining Value of the Business for Buy-Sell Agreements
Executing a buy-sell agreement or other contingency transaction plans requires a predetermined estimation of the value of the business. It is essential that a valid method for determining an accurate value be used. The buy-sell agreement may have been drawn up long before the time that the value of your business is needed. However, when a triggering event puts the buy-sell agreement in action, the most accurate value of your business will be needed.
Employing the services of a CPA or a business valuation analyst is the best way to get the most accurate value of your business. There are several methods they can use and they should know which method is best for your type of business. Determining the value of a small business can be less complicated. There are online business value calculators that can walk you through determining a value for your small business.
What a Buy-Sell Agreement Must Include
An effective buy-sell agreement needs to include the following factors:
- What events will trigger the buy-sell agreement (death, retirement, disability, etc.)
- How will the buy-sell agreement be funded (life insurance, cash, disability insurance, etc.)
- How the valuation of your business will be determined and by whom
Creating such an important document should be done with the legal advice of an attorney. A buy-sell agreement can salvage a business after the loss of a key partner, so make sure to take the time and build a proper contract. To consult with a business attorney, you can start your search with our free tool right now and find attorneys near you.