The average business owner spends 10 hours per day, six days per week to get their business to the point where it can provide a measure of security for their family. When the business is owned by partners, all those hours of work can go to waste if they fail to establish a plan in the event one of them suffers an untimely death. Only by planning ahead can the survivor be assured of a smooth transition. Likewise, planning guarantees that the deceased partner’s family receives its fair share of the value of the business.
To understand the situation more clearly, consider Fred and Bob, the owners of a printing company. Fred has the sales expertise and Bob runs the production side of the operation. Their overall profitability is due to their joint efforts. If Fred were to die prematurely, Bob would have to hire a new employee to fill Fred’s position. With the new hire, it’s unlikely that they could duplicate Fred’s results. At the same time, Fred’s widow would want to continue to take the same money out of the business that Fred had received. In fact, if Fred’s widow is raising a young family or has children in college, she may have to force a sale of the business at distressed prices just to meet her needs. Needless to say, it may be impossible for Bob to continue a profitable business under such circumstances. However, such a situation can be avoided. A properly drawn and funded buy-sell agreement can prevent such a disastrous result.
A buy-sell is an agreement between the owners of a business which details what is to occur upon the death of one of the owners. Such agreements can also deal with the situation where one of the owners becomes disabled, retires, divorces, or wishes to sell their interest in the business. Typically, the buy-sell agreement provides that the surviving owner of the business will purchase the deceased or withdrawing owner’s share of the operation. The agreement should set forth the purchase price to be paid or should provide a formula for determining the price. Perhaps most importantly, the agreement must have a mechanism for providing the funds needed to make the purchase. For example, if Fred’s interest in the business is valued at $100,000, Bob would probably have difficulty raising the funds to purchase Fred’s interest. One way to handle the problem is to require the purchase of life insurance. To meet this need, insurance companies sell a so- called “first to die” policy which pays a death benefit on death of the first business owner, thereby ensuring that funds are available for the buy-out regardless of which partner dies first.
As you can see, the buy-sell agreement provides assurance to the surviving owners that the business will continue in a successful manner. At the same time, it provides the deceased owner’s heirs with funds that will enable them to meet their needs and pay estate administration costs. Overall, the buy-sell agreement gives everyone comfort and security that they will receive maximum benefit from the business that they worked a lifetime to establish.