The Future Success of Your Business May Hinge on a Proper Buy-Sell Agreement Between Owners
Buy-sell agreements are invaluable agreements between owners of a business.
In companies with multiple owners, buy-sell agreements outline the terms of departure for one of the owners, mainly the division of their interest in the business. Buy-sell agreements typically dictate who will receive the departing owners’ interest, how much will be paid to the departing owner for it and provide the cash for funding the purchase. A properly written buy-sell agreement is key to business succession planning because it assures a smooth transition for the business when one owner retires or departs for other reasons.
There are two basic types of buy-sell agreements.
Redemption Buy-Sell Agreement
The first is a redemption buy-sell agreement. This is an agreement in which the business entity itself (i.e., the corporation) purchases the interest of the departing owner. This means that the remaining owners own a bigger percentage of the business.
Cross-Purchase Buy-Sell Agreement
A cross-purchase buy-sell agreement is the other basic type of buy-sell agreement. This involves the remaining owner or owners individually acquiring the interest of the departing owner. In businesses with multiple owners, it is possible for one owner to acquire all or most of the departing owner’s interest and own a bigger stake in the business, or all owners acquire an equal portion or the interest of the departing owner keeping the ownership proportions the same.
There are numerous benefits to buy-sell agreements for both your business and a departing owner. Guaranteeing a purchaser for the departing owner’s interest avoids the hassle of finding someone to purchase their interest. While this may not seem like a problem for successful businesses, remaining owners often must approve any new owner purchasing an interest in the business. Certain owners may not want others to receive an increased ownership share in the business. These and other issues can be avoided by naming a buyer beforehand.
Buy-sell agreements allow owners to agree to financing for the transaction before it occurs, which avoids the trouble of forcing the departing member and the buyer to go through unknown financing methods. They also guarantee the business will continue to operate as it has and will not be interrupted by any conflicts resulting from the transfer of the departing owner’s interest.
By establishing a fair market value of the interest prior to the departure, buy-sell agreements also assure heirs of a deceased business owner that they will receive a fair value for their loved one’s interest in the business. Many family members have no idea what the deceased owner’s interest in the business is worth and unfortunately this leaves them vulnerable to being taken advantage of by the remaining owners. Setting a predetermined value for the business interest, which is updated frequently, assures that family members will receive fair value and there will be no argument over what the business interest is worth.
This value can also be used for tax purposes as well, as the government will allow the buy-sell agreement to establish the value of the business if three strict requirements are followed:
- The buy-sell agreement is a bonafide business agreement;
- The buy-sell agreement is clearly not an attempt to transfer your business interest to a family member for less than adequate consideration; and
- The terms of the buy-sell agreement are like other arrangements of the same general type in other businesses.
A proper buy-sell agreement between you and your co-owners can be critical to the future succession of your business in New Jersey. When correctly written, these agreements guarantee the successful transfer of your business while avoiding the tedious conflicts that tend to arise without such an agreement.
If you have any questions regarding the benefits of a buy-sell agreement or would like to discuss the future of your business succession planning, please call Fredrick P. Niemann, Esq., a knowledgeable NJ Business and Estate Planning Attorney. He can be reached toll free at (855) 376-5291 or by email at firstname.lastname@example.org. You’ll be happy to know that he is very approachable and experienced in New Jersey business and estate planning.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Business Law Attorney