Buy-sell agreement critical to continuity.

The scenarios run the gamut from the ridiculous to the tragic: Your partner wins the lottery and decides not to work another day. Or he or she wakes up one day and decides to pursue his/her true life interest, whether that means purchasing a winery, painting full-time, or bicycling across the country. In a less than happy ending, you and your partner have "irreconcilable differences" regarding how to run the business. Or your partner is unexpectedly disabled or passes away. In any event, the difference between the continuity or failure of your company can come down to having a well-written buy-sell agreement in place.

Today, companies with multiple owners must-have a solid, well-planned buy-sell agreement that prevents the unrestricted transfer of ownership interests and stipulates the next step when one of the owners dies, becomes disabled, retires, or otherwise withdraws from the business.

The ideal time to draft a buy-sell agreement is when the company is launched. But if you do not have such an agreement in place, pull together your team of professional advisors--your accountant, attorney, insurance agent and an expert in business valuation--and have such a plan drafted. This process will help the owners understand all aspects of the agreement and make certain that it is a good fit with their long-term goals.

Setting the Buy-Sell Agreement in Motion

When drafting a buy-sell agreement, the current owners have to decide which actions will trigger the agreement, such as death, disability, termination or voluntary withdrawal. However, it does not have to be limited to such obvious causes for withdrawal and can be used to govern any activities the firm feels are important for the owners to perform, such as keeping professional licenses current.

Purchasing Interest

Once the firm decides what will trigger the agreement, the owners have to decide how to purchase the former owner's interest. There are several combinations either the current owners or the company itself can use to purchase the interest:

* The remaining owners can buy the former partner's interest (a cross-purchase agreement).

* The company itself can redeem the interest (a redemption agreement).

* The company and owners can split the interest.

* The owners can be given a right of refusal before the company purchases the interest.

Valuation

With the method of distribution in place, the owners need to determine the value of the shares. The owners have a great degree of flexibility in this endeavor. The determination of value can involve creative formulas based on the company's earnings, be tied to the company's book value, come from a declaration of value, or be determined by an independent business valuator. The buy-sell agreement should include a baseline purchase price, the terms of payment, and the formula for determining value when a "triggering event" occurs.

Terms and Structure of Payment

There are various ways to fund a buy-sell agreement, including insurance, bank loans, self-funding by the company, and cash, should there be enough liquidity in the company itself.

Perhaps the most common method is through the purchase of life insurance policies on each of the owners. Or the owners may choose to purchase a first-to-die policy, covering both owners at a lower premium, that pays upon the death of the first owner. Which method is preferable depends on the facts and circumstances in each case.

There are very different tax consequences depending on the legal structure of the company (C Corp., S Corp., LLC, or partnership) and whether the policy is owned by the company or the owners, which underscores the importance of structuring such an agreement with the help of an advisor.

Additional Benefits

In addition to the protection afforded by a buy-sell agreement, the presence of such an agreement may also make a company more attractive to banks, bonding companies, or portential acquirees. The last thing lenders want is to have to take over a company in turmoil or one which is plagued with uncertainties about its future ownership. In addition, the process of creating the buy-sell agreement forces company owners to discuss estate planning issues that sometimes also go unaddressed.

Simply put, a buy-sell agreement is not just a good idea; it is a necessity to ensure the continuity of your business. Should you need assistance in creating such an agreement for your company, consult your Anchin relationship partner.

By MARC NEWMAN, CPA 

ANCHIN, BLOCK & ANCHIN LLP