How do you make sure the family business, farm or ranch you worked so hard to build passes to your heirs, stays out of the hands of former spouses, or provides income when you retire or experience some other life-changing event?
The simplest, most effective way is to develop a business continuation or succession plan, often in the form of a buy-sell agreement. A properly planned, structured and funded buy-sell agreement creates a ready market for a business or business interest and includes a means to fund the purchase of part or all of the business.
According to the Deloitte Business Succession Planning Series, only 30 percent of family-owned businesses survive into the second generation, 12 percent survive into the third and just 3 percent operate into the fourth generation and beyond.
A family business survey conducted by the National Bureau of Economic Research Family Business Alliance found 43 percent of family-owned businesses don’t have a succession plan. That’s a scary statistic if you want your family business to be a source of retirement income or pass to the next generation or a designated successor.
What are the most common buy-sell agreement options?
An entity plan — a corporate stock redemption agreement or partnership liquidation agreement among owners or partners triggered by specific events that include death, divorce, disability or retirement of an owner or partner. In this situation, the agreement specifies which owners will buy which shares and at what price once a triggering event occurs. This ensures ownership and control of the business stays with the business — the entity.
A cross-purchase agreement — an agreement among owners or partners to buy one another’s shares under specified scenarios. The remaining partners or owners agree to buy the departing, deceased or disabled person’s shares in an agreed-upon proportion.
A buy-out agreement — an agreement among the owner or owners and one or more key people, family members or outside individuals generally for the purpose of ensuring orderly transfer or succession. This includes non-owners — family members or other parties — who’ve entered into the buy-sell agreement to buy out the shares of one or more owners or partners.
All three options offer a valuable benefit. They establish a guaranteed or predetermined market for selling the business to a buyer who’s prepared, willing and able to buy. In the case of a professional practice, this includes a qualified buyer.
When should you consider establishing a buy-sell agreement? Here are some of the more common situations:
When you need a guaranteed market for selling your business in the event of death, divorce, disability or retirement.
When the law restricts who may own or participate in the business, such as a law or medical practice, insurance advisory or other businesses requiring professional licenses.
When you’re doing estate or tax planning and need to establish a value for the business. In this situation, it’s advisable to work with a professional business valuation consultant or similar professional.
When one or more owners would not want to operate the business with a deceased owner or partner’s heirs.
When the intent is to keep the business or part of the business out of the hands of competitors, former spouses or unqualified heirs.
A buy-sell agreement is usually completed in writing and binding. The agreement includes the parties involved; a purchase price, formula to determine the purchase price or stock valuation process; terms of the purchase and sale; and how the agreement will be funded.
When a buy-sell agreement is triggered, the defined business interest is sold to the business itself, the other owners, a qualified third party, the heirs or some combination of the preceding.
This column is intended only as a general overview. More details will be provided in subsequent columns. It’s essential to engage with licensed professional advisors — accountants, business valuation consultants, financial and insurance advisors and lawyers — before establishing a buy-sell agreement.