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The Keystone of Business Continuity - Crafting Effective Buy-Sell Agreements

posted by TrueNorth Transportation on Thursday, June 13, 2024

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Why Buy-Sell Agreements Are Essential

Buy-sell agreements are critical for business continuity, ensuring smooth transitions when owners leave due to unforeseen circumstances. While it may be uncomfortable for business owners to contemplate scenarios such as the death of a partner or other events leading to their exit, having a well-crafted buy-sell agreement is essential.

Without a proper legal agreement between all owners of a business that outlines the terms and conditions under which an owner’s interest can be bought or sold following such an event, there is the potential for many complications.

At the recent TrueNorth Risk Summit, Jeff Ditsworth and Jay Robinson led a breakout session discussing Buy-Sell Agreements, key considerations, and what to avoid.

Understanding Buy-Sell Agreements

Partnerships, closed corporations, and sole proprietorships should consider having a buy-sell agreement in place. This enables all owners of the business to come to an agreement on transition of interest in the event of a triggering event including divorce, disagreement, disability, distress or death.

Each party should acquire their own legal counsel to represent their interests when establishing this agreement.

Without a buy-sell agreement, business owners may find themselves in less-than-ideal situations such as:

• Gaining new, unexpected business partners
• Tax and financial issues
• Loss of time and money due to litigation

Common Pitfalls and How to Avoid Them

One critical aspect of a buy-sell agreement is establishing a valuation method that everyone agrees upon and determining how frequently this valuation will be updated. Without this, parties may disagree on the value following a triggering event.

Another common pitfall is a lack of funding for buy-sell agreements. People should consider 5 funding methods, each have their pros and cons:

1. Cash: Immediate payment but may strain the business’ liquidity.
2. Sell assets: May affect business operations and value.
3. Borrow: Increases debt and financial obligations.
4. Installments: Spreads out payments but may prolong financial obligations.
5. Life Insurance Portfolio: Provides immediate funds but requires careful selection and management.

Life Insurance Funding Hazards

Life Insurance policies are the most common method used to fund buy-sell agreements. However, there are 5 common hazards to avoid when selecting this method:

1. Life Insurance Agents: Ensure they are knowledgeable and trustworthy.
2. Underwriting Limitations – Choosing the wrong insurance company: Choose the right insurance company to avoid coverage issues.
3. Life Insurance Design Options – Choosing the wrong product: Select the appropriate product for your needs.
4. Lack of Access/Education to Institutional Grade Insurance: Ensure you have access to high-quality options.
5. Life Insurance Portfolio Management: Regularly review and manage your policies.

Enhancing Business Value and Peace of Mind

Having a buy-sell agreement in place ensures a smooth transition in the event of a partner leaving the business or another triggering event occurring. This enhances business value by preventing on-going financial risk and provides owners with peace of mind.

If you’d like more information on the Risk Summit session covering this topic, please fill out the form below: