Protecting Business and Family with Buy-Sell Agreements by Sharon Foote, ASA, CFE
Posted on November 30, 2015
For many people, there are few things more important to them than their family and their business; sometimes the two are intertwined. By taking steps to protect their business, they are also protecting their family. Every day that value is added to a business without a plan for future transition, it increases the owners’ financial risk.
Ideally, the co-owners of every multi-owner business puts in place a buy-sell agreement at the time his or her company is formed as part of the start-up process. A buy-sell agreement protects both the remaining business owners and the co-owner who leaves the business should what is referred to as a “triggering” event occur. If a co-owner wants to: retire, sell his or her interest, goes through a divorce, declares bankruptcy, or dies, a buyout agreement acts in a similar way to a “prenuptial agreement” by protecting everyone’s interests, either setting the price and terms for a buy-out, or the process for determining them.
No one likes to think about divorce but, if a co-owner of a business is divorcing, can his or her spouse ask for part ownership in the business? That risk does exist. In community property states such as Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin, all monies earned and all property acquired with those earnings are included in the community property, owned equally by both spouses and each can claim a right to such property. A spouse in a non-community property state (such as Florida) may argue for a partial interest in the business since marital property laws require the equitable (not necessarily equal) distribution of property in a divorce.
The best way to avoid this eventuality is to make sure that the buy-sell agreement requires the ex-spouse to sell any interest received as a result of the divorce back to the company, or other co-owners, in accordance with the provisions specified in the buy-sell agreement and include the then spouse as a signatory.
It helps for the co-owners to agree on the process to be used to value the company in advance from the beginning within the buy-sell agreement. Agreeing on the valuation process ahead of time will reduce conflict if and when the situation requiring a buyout comes about.
However, another issue can be the funding of such a redemption. If a lump-sum payment is required, it can inhibit the company’s ability to repurchase a co-owner’s interest. Building flexible payment terms into the buy-sell agreement may (again) prevent problems from occurring at a later date with execution of the buy-out or having an adverse affect on the business itself from stretching its resources too thin in order to rebuy the interest.
Buy-sell agreements have been used successfully to reduce estate taxes in businesses where one or more of the co-owners wish to bequeath his or her interest to family members without burdening them with avoidable estate taxes caused by an overly zealous valuation of the business enterprise. By choosing a more conservative valuation formula or process for the business in the buy-sell agreement, the value of the ownership interest may be significantly less than its sales price determined upon the death of the owner. Provisions can also be made in the buy-sell agreement that allow insurance to be used to fund the repurchase of the deceased owner’s interest.
There are many situations such as those mentioned in this article that can occur where a buy-sell agreement could benefit all parties concerned. Without a proper buy-sell agreement in place, a business co-owner may find himself running his business with an outsider or an ex-spouse. An owner nearing retirement may discover the company is not obligated to buy back his or her stock. Even worse, a majority owner who desires to sell his or her interest may have its sale vetoed by minority owners. These kind of situations can be avoided with a well-crafted buy-sell agreement.
What’s the message here? It is in the best interests of all business co-owners to protect themselves by making sure there is a thorough, well thought out buy-sell agreement in place. The future of their businesses, their families and themselves may depend on it.
About the Author: Sharon Foote, ASA, CFE, is a manager in the Business Valuation and Litigation Support Practice of Berkowitz Pollack Brant. She can be reached in the CPA firm’s Miami office at (305) 379-7000 or by email at firstname.lastname@example.org