Does Your Small Business Need a Buy-Sell Agreement

Every small business starts out with high hopes for future success. Along the way, however, there will be numerous challenges. And if your business has two or more owners, there will be times when the owners have serious disagreements. There may also be instances when one (or more) of the owners needs to sell their interest in the business. In such cases, it is important to have a buy-sell agreement. Business Buy Sell Agreement

When should a business set up a buy-sell agreement: If you have a business with more than one owner, the answer is as soon as possible. Ideally, this agreement should be drafted in the beginning before opening for business. If you let too much time pass, it will be difficult to come up with an agreement that will satisfy all parties involved.

How does a buy-sell agreement protect business owners: A buy-sell agreement is a binding contract between the owners of a business that spells out the specific terms and conditions in which interest in a business can be sold. This protects owners in several potential circumstances. Some of the most common include:

Owner Death or Retirement: If an owner dies, has serious health issues or decides to retire, you could end up with a spouse or family member as a partner, which may not always be a desirable circumstance. A buy-sell agreement can give the other owners or the company the right to purchase the departing owner’s interest.

Owner Divorce: When an owner gets divorced and there is no buy-sell agreement, there is a good chance the ex-spouse may end up owning part of the business, particularly in community property states (such as Arizona) where marital property and earnings are considered to be equally owned by both spouses. A buy-sell agreement can resolve this issue in advance.

Owner Bankruptcy: If one of the business owners is insolvent and files personal bankruptcy, the entire business can be tangled up in bankruptcy court. A buy-sell agreement can mandate all owners to notify their partners before filing bankruptcy, and this notification can become an automatic offer to sell their interest in the business prior to the filing.

Business Valuation and Other Terms and Conditions: When drafting a buy-sell agreement, the owners must put a lot of thought into how they will value the business for the sale, and the method of purchase. There are several ways of valuing a business (e.g. market value, assets owned, net income), and sales can be structured as lump sum purchases or installments over time. These terms and conditions could have major tax implications. For example, if the seller receives a lump sum payment, it could put them in a higher tax bracket for that year, forcing them to pay more in taxes. Before crafting your buy-sell agreement, speak with your small business accountant to discuss these important issues and how to ensure that all parties are positioned to minimize tax consequences.

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