Why Not Having a Buy-Sell Agreement is a Crazy Risk
Many business owners put in an enormous amount of time and effort into making their businesses successful. As reported by Inc.com, “Thirty-three percent of small-business owners reported working more than 50 hours per week, while an additional 25% said they work more than 60 hours a week” while the national average was “33.8 hours per week [as] reported by the Bureau of Labor Statistics.” In short, many business owners put in nearly twice as many hours as the average worker trying to make their businesses succeed.
They do this for decades on end because they’re invested in the success of their business. There are as many reasons for this as there are business owners working to succeed.
However, whether they’re trying to create a legacy, experience the satisfaction of building something, fund their retirement, or simply just want their business to be the best as a matter of personal pride, a lot of people who are owners of their business end up taking a crazy risk with their business.
What is this crazy risk? Not having a clear, written and legal succession plan—often called a “Buy-Sell agreement” that lays out what happens if an owner or co-owner can no longer run the business. The tragedy is most owners are too busy working on their business to take this basic step to protect their most valuable asset—their business.
In fact, 2/3 of entrepreneurs have not established their professional exist strategy, and only 21% of them have a buy-sell plan in place in the event of death.
What is a buy-sell agreement, and why do business owners need to make sure they have one in place that reflects their current business and ownership structure? I’ll try to explain this to the best of my ability:
What is a Buy-Sell Agreement?
When we reference the term buy-sell agreement, we’re specifically talking about a legally-binding agreement made between the owners of a business where one business partner agrees to buy out the other’s share or interest in the business if the other partner decides to leave or is unable to work at the business for specified reasons.
In short, a buy-sell agreement is a kind of contingency plan for keeping the business going despite the loss of one of the business’ partners/owners or to provide funds for you (or your family) in case you have to leave the business for any reason, the most common being death and disability.
The conditions under which the buy-sell agreement is activated are specified when the legal document is created, as well as any exemptions or limitations.
Equally important is that there is a plan to fund the buy-sell agreement, or else the buyer(s) may find themselves short on funds and forced to sell assets under duress. In some extreme cases, failing to find a way to finance the buyout can result in the need to file for bankruptcy, particularly where a company is carrying a lot of debt and the bank is forcing the heirs to pay off the debt in a short time period.
Some funding options for buy-sell agreements include buying some form of insurance (such as life or disability insurance), setting up a cash reserve fund, using installment payment plans, and setting up deferred compensation plans, among other options.
Why You Need a Buy-Sell Agreement
If you are a co-owner or partner in a business, a buy-sell agreement is a critical piece of protection for your business interests. It can help prevent the disruption of business operations, or provide you with funds if you are forced to leave the business. Perhaps more important, it can provide funds to a business owner’s heirs in the event of death, assuming there are assets in place to fund the buy-sell agreement.
Say that you enter business with someone a few decades older than yourself, someone approaching retirement age. In this instance, the buy-sell agreement helps you by giving you a chance to buy your business partner’s interest in the company if he or she decides to retire or (unfortunately) passes away before you.
In this case, you have a better chance to assume control of your partner’s share in the company with a minimum of disruption.
Or maybe the opposite is true--that you enter business with someone several decades your junior. Here, the buy-sell agreement would help make sure that you have a chance to receive fair compensation for your portion of the business when you retire and leave the company. Many would prefer this over having to gamble on successfully selling the business for its fair market value to strangers. Completing a successful sale process is time consuming, involves a great deal of negotiation and stress, and has no guarantee of success.
In this case, you would have a better chance to increase your financial security in retirement by selling your portion of the business to a junior partner.
If you are the sole owner of your business, what would happen if one day you weren’t able to go into work? Would the business continue to be run as it is today? Would it continue to be profitable and deliver a healthy income to your family? Or if you are co-owner of a business and your partner doesn’t come into work one day, are you prepared to be business partners with your current business partner’s spouse?
While a buy sell agreement might not guarantee uninterrupted continuity for your business (especially if the conditions for triggering the agreement were not met), your odds are generally better with a well-crafted agreement than they would be without any kind of contingency plan.