What happens in a business when you only own half the pie?
What is a business Buy-Sell agreement?
A Buy-Sell agreement is a documented contract between two or more business partners where they agree ahead of time, how their valuable interests in the business will be transferred to the remaining owner(s) if one business owner suffers a documented trigger event.
- Such trigger events could include death, serious illness or injury, permanent disability, retirement or resignation.
When would I need a Buy-Sell agreement?
You need a Buy-Sell agreement whenever you are in business with another person.
- This includes Partnerships and Multi-owner company structures where there is more than one single business owner.
- Members of a Unit Trust ownership structure often incorporate a Buy-Sell agreement within their Unitholders agreement.
Why would I need one?
For the majority of small business owners, the ownership of their business is one of their main financial assets; and for many, their ability to ever afford to retire is tied to its successful future sale.
For small business owners and their families, a lot is riding on the stability of their business, growing its value, and ultimately getting back the money it owes them through a successful sale to another person.
- Being in business with another person (or persons) increases the known statistical risks of business interruption (not decreases) to manage.
Why hasn't my Accountant advised me about this need?
- Many business owners like to think their Accountant will proactively advise them of every single risk to be managed in their business.
- Many Accountants think their business owner clients will proactively ask them for advice about the risk to be managed in their business.
You can see how missed expectations can lead to a core business risk being missed.
What does a Buy-Sell agreement cover?
Buy-Sell agreements can be specific and provide for Business Debt Protection, or can be more board to cover all aspects of a future business exit.
Businesses involving multiple owners should always have a governing document that outlines what has been agreed to by partners and stakeholders, and what will happen if a particular event occurs.
- A Partnership agreement or a Shareholders’ agreement governs the day-to-day operations and decision responsibilities, and
- A Buy-Sell agreement governs the future exit strategy for the business owners.
- A Buy-Sell agreement can also provide the agreed roadmap for repaying a business debt.
The 'Will' of the Business
A Buy-Sell agreement is often considered the 'Will' of the multi-owner business and documents ahead of time the agreed method of dealing with an owner's exit from the business. The urgency of establishing this agreement is that most business exits are unexpected, unplanned, and high-risk to all parties.
- The first part clarifies the agreed valuation method of the business and what the insurable trigger events are.
- The second part of the agreement addresses how to pay for the departing owner's share of the business.
Agreements usually also cover:
- The specific trigger events to be covered by the agreement,
- Whether a sick or injured partner can still draw an income from the business, and for how long.
- What method of business valuation will be used if one owner’s share of the business needs to be sold,
- Give the parties to the agreement the option to purchase another partner’s interest following certain agreed trigger events, usually the death or incapacity of a partner, but also divorce, and
- Require the remaining parties to the agreement to purchase and buy out the existing partners (or their families who may inherit the ownership shares of a business) in a set period of time, and
- Set out the funding method to be used – usually a Life insurance policy, a Critical illness or Disability policy – to buy out a partner's share of the business.
Funding a Buy-Sell agreement
Life Insurance is commonly used to fund a trigger event departure as it avoids the need for remaining owners to use personal savings or borrow money. Insurance covers trigger events such as death, total and permanent disability, or serious illness or injury that also meets the terms of the insurance policy.
Other funding options (such as savings, loans, investment bonds, or deferred purchase agreements to make payments over a number of years) need to be considered for any trigger events in the agreement not covered by the insurance. Examples are retirement or resignation bankruptcy or directorship disqualification.
How relevant is a Buy-Sell agreement at the early stage of business?
A Buy-Sell agreement is a core business legal document that only reduces the risk once it is in place.
- If your business partner had to leave the business tomorrow, how would you afford to buy out their share of the business?
- What would happen if they sold their share to a competitor?
- What would happen if they used the company chequebook to purchase a Ferrari and then abandoned the business and their financial responsibilities to it (because it's only your home that was used to cross-secure the company debts)?
- What would happen to the business if their share was inherited by their family members whose plan for the business was very different from your own?
How would this put at risk everything you have built so far?
Not having a documented Buy-Sell agreement is beyond high risk
Not having a Buy-Sell agreement in place usually leads to decision deadlock during the most stressful time in a business ownership transfer, litigation, and the destruction of the business value, when faced with the unexpected departure of a business owner.
Problems associated with business partners departing a business because of unexpected sickness, injury, disability, terminal illness or even unexpected death, are best managed ahead of time by making a Buy-Sell Agreement between the business owners and partners.
Without a written Buy-Sell Agreement about this, you could end up in business with your former partner's family.
Where to now?
- Contact Sapience Financial and request a pre-insurance assessment on the business owner's insurability.
- Request your accountant to provide a Business Valuation
- Determine the percentage of business ownership, each owner holds
- Request a life insurance quote on each business owner to the value of their business interests to start your conversations.
- Then Insure your business to the value of the business valuation
- Document your plans in a legally drafted Buy-Sell Agreement.
- Store the executed document in safe keeping, preferably offsite.
- Meet with your Sapience Financial Adviser every 2-3 years to confirm the business valuation is still current and adjust your insurances as needed to match any future valuation changes.
This way all the business owners (and their families) will have certainty there is an agreement in place ahead of time, just in case, that provides certainty and clarity about what happens if one of the business owners or partners unexpectedly exits the business.
How we can help?
There are three elements needed in the creation of a Buy-Sell agreement provided by three separate professionals all working together; your Accountant, your Solicitor, and your Sapience Business Financial Advisor acting as your project manager for this key business transaction.
- Sapience Financial works with your Accountant (who provides your business valuation) and your Solicitor (who drafts the Agreement) to provide the funding strategy (using life insurances on each of the business owners) to help fund your Buy-Sell agreement and its valuation purchase price, using Life Insurances.
Contact us for a confidential chat about your needs.
Related: Key Legal Documents for Business Owners
- Non-Disclosure Agreements (NDA)
- Company Power of Attorney (CPO)
- Partnership Agreements
- Shareholders Agreement
- Unitholders Agreement
- Loan to Company Agreement
