If you share ownership of your business with one or more parties, you should have a buy sell agreement in place. It will protect everyone’s business interests should an owner wish to leave the company or experience significant events like divorce or retirement.
1. Question: When is a buy sell agreement appropriate?
The agreement should be in place at formation of the enterprise or as close to it as possible. Installing a buy/sell agreement will minimize financial risk for your business.
2. Question: What is the purpose of a buy/sell agreement?
Despite what the name may imply, buy/sell agreements actually have fairly little to do with the sale and purchase of the business. Instead, think of the document more like a prenuptial agreement. With the document in place, the business owners are linked and the rules are set for when or how each owner can sell her or his respective interests. Because the agreements usually are limited to transactions between business owners, sometimes they are called buyout agreements. Typically, these agreements are only enforced in the event of:
3. Question: In the event of divorce, will the owner’s former spouse gain partial ownership of the company?
Transfer of partial ownership to a former spouse after a divorce is possible, depending on the local state laws. If your state has a community property law, any assets acquired during marriage are part of community property. In the event of divorce, business interests will likely be counted as community property, and therefore subject to being split between the two divorcing parties. If you live in a non-community property state, former spouses may still make a reasonable claim for partial ownership depending on the length of the relationship, when the business interest was acquired and other factors. With a valid prenuptial agreement, owners can protect their business interests from being counted as “community property.” Additionally, an excellent buy/sell agreement will likely prohibit the transfer of business interests to former spouses in the event of divorce. Instead, the former spouse will be required to sell back the business interest to company owners in exchange for assets.
4. Question: If one owner files for personal bankruptcy will this affect the business?
Yes, if an owner files for personal bankruptcy, the bankruptcy trustee may have to liquidate the company if the owner’s assets cannot satisfy personal debts. To guard against this risk, buy/sell agreements typically have a clause to address the situation. Usually, the owner filing for bankruptcy is required to inform all co-owners. This alert is treated as an offer to sell the filing owner’s business interest back to the company.
5. Question: Is there a right way to determine company value in the event of a buy out?
The best way to determine company value at the time of sale is to hire a third-party appraiser. However, you also want to define your valuation formula in your agreement. Otherwise, each company owner may hire her or his own appraiser with different valuation methods, leading to a drawn out negotiation process. There isn’t a right valuation formula for every company, so work with your co-owners to find what would be fairest to all. Put that formula into your agreement to smooth out any future sales.
6. Question: What if the company can’t afford to buyout an owner when the time comes?
The best way to solve this situation is to avoid it. Don’t require an immediate and full lump sum to be paid to the selling party at the time of sale. Instead, opt for a more flexile payment scheme and you’ll reduce the risk of not being able to buyout someone when needed.
7. Question: Can buy sell agreement minimize estate tax?
With the right wording, you can avoid or minimize potential estate taxes at the time of your death. Consult with an experienced attorney before modifying your agreement.
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