The Importance of Buy/Sell Agreements

Posted 10-11-2014
Written by admin 101

Buy/Sell Agreements are often viewed as the “Will of a business”, as they enable an owner to transfer their interest to the other remaining owners, when certain specified trigger events occur.

The most common triggers are death, long term or permanent incapacity and trauma. Under the Agreement, when one business owner is impacted by such an event, they consent to sell their shares of the business, while the remaining owner agrees to purchase that outgoing person's interest.

Buy/Sell Agreements take precedence over Wills that may have been executed by individual owners of the business. Agreements are generally funded by life insurance policies on the outgoing owner.

Survey results show that more than 70% of business owners in Australia have no form of written business succession plan. Even though 38% of the business owners know about Buy/Sell Agreements, only 9% actually have one in place – a startling figure considering they are such an effective means of providing certainty for the future of the business and avoiding disputes.

In the absence of a Buy/Sell Agreement, the consequences can be devastating. Often the transfer of the outgoing owner's share occurs substantially under value due to the inability of the remaining owners to purchase at market value, or the vulnerability of the outgoing owner caused by the change in their life circumstances.

In worst case scenarios, businesses may need to be wound up.

All stakeholders within the business can receive some advantage from having a Buy/Sell Agreement:

  • Remaining Owner: the Agreement prevents the doubts and worry of not knowing who will take on the outgoing owner's business share. Given that the insurance policy finances the purchase, they don't need to dig into their own pockets or borrow to finance the buy-out. It also eliminates the risk of potentially unsuitable third parties, such as spouses, family members or friends, from buying in regardless of what the outgoing owner's Will may stipulate.
  • Outgoing Owner: the Agreement guarantees sufficient compensation for disposal of the departing owner's interest. Additionally, it voids the person feeling guilty about leaving the business, such as deteriorating health, trauma and, in some cases, retirement.

Buy/Sell Agreements play a key role in business succession. They reduce the stress and unnecessary complications involved in replacing fellow business owners, ensuring the best policy outcome for all stakeholders. While there is some expense involved in taking this policy, the costs of not having an insurance-funded Buy/Sell Agreement could be much more costly.