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How Does A Buy-Sell Agreement Work?


Article by Oren Ross

Photography by Oren Ross

A buy-sell agreement is a plan for selling your business in case you become incapacitated, retire, or pass away. With a buy-sell agreement, a business owner can sell their share of the business, allowing other owners—or completely new owners—to buy their stake in the company. The buy-sell agreement lays out important decisions ahead of time because it contains stipulations on how the transition of ownership of the business should take place.

What Are the Key Elements of a Buy-Sell Agreement?

As a general guideline, your buy-sell agreement should have at least five key elements. First, you should include a valuation clause to document how much your business is worth and ensure that a fair purchase price is defined. Second, you need to define how the buy-sell agreement should be funded. There are many different options, including life insurance proceeds and split-dollar insurance funding. Third, you need to identify at least one other party for your agreement (the buyer) for it to be valid and to identify any legal or licensing obstacles ahead of time.

Once you have these elements in place, you will need to define qualifying events that will kick your buy-sell agreement into action. Include major life events, such as death, illness, disability, retirement, and divorce, as well as other events, such as a breach of contract. Think about all situations that may require your exit and what should happen to protect your business interests. Finally, you’ll need to structure your agreement in a way to minimize tax liability.

Who is the Beneficiary of a Buy-Sell Agreement?

When choosing life insurance as a way to fund a buy-sell agreement, business owners have a few different options. Depending on how the life insurance was purchased, the beneficiary can be either the business itself or an individual business owner, if the organization has multiple owners. In a cross-purchase agreement, each business owner buys a life insurance policy on each of the other owners and uses the proceeds to buy out the deceased owner’s share of the business. But if the company has an entity purchase or stock redemption plan, the business becomes both the owner and the beneficiary of the policy and can buy a deceased employee-owner’s share of the company with the proceeds from the death benefit.

Why Do I Need a Buy-Sell Agreement?

Think of a buy-sell agreement as a will for your business. There are many reasons why you may need a buy-sell agreement. The main goal of this type of agreement is to have some control over who becomes an owner or executive team member should you step down. It can also help define the fair value of an owner’s share in the company, reducing the risk that other partners or owners may cause disagreements for believing they are not being offered enough money for their share.

You will have a defined exit plan for yourself and your other business partners and can stipulate who may be entitled to your share of your business when you make your exit. And most importantly, you will have a continuity plan for your business to keep running in spite of any unexpected death or illness.

At Oren Ross & Associates, we help business owners create continuity plans to preserve their business and help them leave a legacy. Contact us at (404) 436-1752 for all your business succession planning needs.