What Is A Buy-Sell Agreement, And Why You Need One?

Written By: AEIS

A group of insurance professionals smiles as they gather around a meeting table, discussing buy sell agreements

What is a Buy-Sell Agreement?

A buy-sell agreement is one that creates a clear path for the transition of ownership of a business. This typically occurs if a business partner passes away, or if they simply choose to leave the company for whatever reason.

The agreement dictates that what is left of the business is sold either to the company as its own entity, or to specific remaining members of the business. If a business partner should pass away, their estate is required by law to sell that interest.

A buy-sell agreement like this is traditionally used for sole proprietorship, partnerships, and closed corporations.

A buy-sell agreement is typically created by the business owners or partners themselves, often with the assistance of legal professionals such as business attorneys or corporate lawyers. Consulting with legal and financial professionals experienced in business succession planning and then brokers experienced in buy-sell insurance can help tailor the strategy to meet the specific needs and goals of the business owners.

Who Needs a Buy-Sell Agreement?

Anyone who owns a business with one or more additional people needs a buy-sell agreement.

For example, let's say your only other business partner suddenly passes away. Without a buy-sell agreement, their spouse could suddenly become your co-owner and have a say in the day-to-day operations of the organization. Do you want that to happen to everything you've worked so hard to build?

Or, your business partner could suddenly find themselves in financial or even legal trouble. Before you know it, a bank or other debtor is suddenly your co-owner. This is a less-than-ideal scenario to say the least.

Buy-sell agreements help prevent these types of things from happening. Even if your business partner isn't thinking about leaving right now, they one day will be. Even if you or your partner are in perfect health right now, it may not be that way forever. A buy-sell agreement can help specify exactly what needs to happen should one of you want to leave so that everything you've already worked so hard to build can be preserved in the exact way you want.

How Can a Buy-Sell Agreement Help Business Owners?

Team members shake hands during a buy sell agreement meeting

Maybe the number one way in which a buy-sell agreement helps business owners has to do with how it helps to establish a fair market value for shares.

If one partner wants to be "bought out" of the company, they want to be able to command the highest price possible for their share. If you have a fair market value that has already been established, there is no negotiation (or arguing) that needs to take place. Without a fair market value, what that share is actually worth is up for interpretation and it could lead to a more stressful situation than you would want to deal with.

In a logistical sense, a buy-sell agreement also helps to develop a clear exit plan for any and all business partners at any time. Not only does it specify how a person will leave, but it also indicates exactly what has to happen next. You could make it so that a business partner can not legally disparage the company they left behind, for example. There are all sorts of things you could stipulate depending on your needs. Simply having this type of plan in place can help mitigate financial risk, not to mention eliminate headaches, moving forward.

Finally, a buy-sell agreement benefits business owners by creating a clear continuity plan so that the company can continue to grow and strive. If one of your business partners unexpectedly dies and nobody knows what to do, at a bare minimum you're dealing with a disruption in your normal operations. At worst, the balance of power is suddenly shifted and you have no idea when or even if things will be able to return to "normal."

A buy-sell agreement helps to establish a much-needed sense of business continuity. If someone should suddenly leave or unexpectedly pass away, the role that everyone has to play is crystal clear. You know what steps must be followed to avoid disruption and how certain risks need to be addressed immediately. No matter what, this will help avoid the type of disruption that could cause significant reputational damage to those left behind.

How to Fund a Buy-Sell Agreement

One of the ways to fund your buy-sell agreement is through life insurance policies. This is only applicable when one of the owners has passed away since the death benefit for life insurance is only triggered by a death. Funding a buy-sell agreement with life insurance can be a smart strategy for businesses to ensure a smooth transition of ownership in the event of a partner's death.

The process involves several key steps. Firstly, as mentioned above, the partners must determine the value of the business and establish a buy-sell agreement outlining the terms of the arrangement. Next, each partner purchases a life insurance policy on the life of the other partner(s). These policies are typically either term or permanent life insurance policies. The ownership structure depends on various factors such as tax implications and the specific needs of the business.

In the event of a partner's death, the surviving partner(s) can use the insurance proceeds to buy out the deceased partner's share of the business at the predetermined value, ensuring continuity and stability for the company. It's crucial to review and update the buy-sell agreement and insurance policies regularly to reflect changes in the business's value and ownership structure. Overall, funding a buy-sell agreement with life insurance provides a cost-effective and efficient way to safeguard the future of the business and protect the interests of all parties involved.

Key Person vs Buy-Sell Agreement

Key person is actually a form of buy-sell agreement insurance, making it different from a buy-sell agreement from the start. Key person insurance is a type of policy designed to protect your business from the sudden loss of a valuable person, like a business partner. It helps to make sure that routine business operations are able to continue should someone suddenly pass away, for example.

A meeting table with coffee cups, laptops, papers, and other miscellaneous office items

A buy-sell agreement, however, is a legally binding document that addresses what happens next. So from that point of view, a good way to look at it might be that key person insurance helps cover you in the short term, whereas a buy-sell agreement is all about making sure the long-term story of your business plays out as smoothly as possible.

Fund Your Buy-Sell Agreement with AEIS

At AEIS, we offer employee benefits consulting and other services to help make sure that your business is always functioning exactly as it should be. We always take the time to get to learn our clients individually, all so that we can put together the customized plan they need to thrive. In a best-case scenario, your business itself - meaning its people, policies, and how it runs - should be your competitive advantage in the marketplace. We want nothing more than to help you accomplish precisely that.

If you'd like to find out more information about funding your buy-sell agreements with life insurance, or if you are ready to fund your buy-sell agreement through life insurance, please don't hesitate to contact the team at AEIS today.