What is a Buy Sell Agreement?
A Buy Sell Agreement is a legal agreement between the owners of a business that obliges an owner to sell their interest in the business to the other owner(s), and for the other owner(s) to buy that interest, in certain circumstances – hence the name “Buy Sell Agreement”.
Typically, the buy sell obligations of the owners will be triggered if one of them dies or is prevented from working in the business because of a serious injury or illness. In that sense, a Buy Sell Agreement is rather like a Will for a business.
A Buy Sell Agreement doesn't usually deal with other situations where an owner no longer wishes to be involved in a business, such as resignation or retirement. Commonly these departures are dealt with in a separate agreement.
Usually, a Buy Sell Agreement will identify the method of funding the buy sell obligations of the owners.
How is a Buy Sell Agreement set up?
A well prepared Buy Sell Agreement will involve a range of professionals working together such as your accountant, financial advisor, insurance advisor and lawyer.
The steps involved in setting up a Buy Sell Agreement basically::
1. The owners of a business negotiate and agree on:
· how their interests in the business will be valued,
· the events that will trigger the buy sell obligations of the owners, and
· how their respective buy sell obligations will be satisfied.
2. A funding plan is established to provide the cash to satisfy the financial obligations of the business owners if any of the trigger events occur.
3. The legal documentation is prepared.
How is a Buy Sell Agreement funded?
Insurance is generally the most cost effective funding mechanism to fund a Buy Sell Agreement, at least for those trigger events that can be covered by insurance (eg death, total and permanent disability and trauma).
If the amount of insurance cover is less than the agreed purchase price for an owner’s interest in the business, the buy sell obligations of the owners will need to be funded from other sources, such as:
· the business bank account
· the sale of business assets
· a bank loan
· a business owner’s personal savings
Depending on how they are funded, Buy Sell Agreements can raise a range of commercial, legal, accounting and tax issues and it is essential that you obtain professional advice on these issues before entering into one.
A Buy Sell Agreement is, by nature, a complex arrangement. If you decide that a Buy Sell Agreement is suitable for you, you will need to consider many commercial, legal, insurance, accounting and tax issues before you establish the arrangement. Your financial adviser can assist you to identify your business needs and the appropriate amount and type of insurance to purchase but cannot advise you on all the other aspects of establishing a Buy Sell Agreement. For all those other aspects you will need to seek appropriate expert advice from legal, accounting, tax and other professionals to determine how best to structure the arrangement.