Why Do Canadian Business Owners Need a Buy-Sell Agreement?
Business owners should plan their future and prepare for the unexpected. As your company starts to grow, you need to think about how you can protect the business that you worked so hard to build. If something happens to you or your co-owners, it could negatively impact your business.
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In case one of you become disabled, unable to work or unexpectedly die, it can only add more burden to your family or the people you are leaving your business to. Trying to sell your business can be too much of a burden for your family who are also going through a challenging time.
To avoid any potential problems, business owners who are in a partnership should set up a buy-sell agreement through insurance. This type of contract ensures that the transition of ownership goes smoothly as you transfer your company to your successor.
What is a Buy-Sell Agreement?
A buy-sell agreement is a type of document that determines the new owner of a business when the current owner becomes disabled, dies or wants to sell his share. This type of agreement has similar features of a cross between a will and a business prenup. It identifies how a business will distribute its ownership and asset in case of termination.
This document serves as an exit strategy for the co-owners as it indicates who owns what in case one of them decides to leave the company. This protects their wishes instead of letting the executors decide the future of the company. This agreement also sets a price for an owner’s interest and how that person’s share can be transferred to the next person to take over.
Do You Need Buy-Sell Agreement for Your Business?
If your company does not have a buy-sell agreement, there are a lot of potential scenarios that may arise. Your former co-owner’s spouse may end up becoming your new business partner or their kids might become part of your company. The bank may end up owning a share in your company or you may find yourself with new partners that do not have any interest in the business at all.
On the other hand, you can avoid all of these headaches by setting up a buy-sell agreement. Here are some of the reasons why business owners should establish a buy-sell agreement.
1. Develops an exit strategy for business owners.
When the co-owners decide to go their separate ways, it can become difficult for the people involved to agree on certain terms of the separation if there is no written agreement. Buy-sell agreements dictate the terms and conditions they need to follow. Having a document on hand will prevent any issues and future claims outside the agreement and make the exit of the co-owner more smoothly.
2. Determines the value price for the shares.
The buy-sell agreement helps determine how much an individual’s share in the business is worth. This makes it easier when one of the partners plan to continue the business even after a co-owner leaves the company. Planning ahead can prevent any potential disputes along the way, specifically when it comes to the numbers and if the offer has a fair price.
This document already establishes the figures ahead. This reduces the risk that your former partner or their successor will demand more money.
3. The business interests remain with the owners.
Without any buy-sell agreement, it increases the risk of having potential disputes of ownership and interests. The buy-sell agreement determines who is entitled to your share in the company should you choose to leave and sell your shares.
Otherwise, your partner’s spouse may take over your share in the company if you don’t have any legal document in place. At the same time, you are leaving the future of your company to the hands of the lawyers which no business owner wants.
4. Serves as a business continuity plan.
Business owners without a buy-sell agreement in place are risking the future of their business and making it vulnerable to potential risks, disputes, and claims. These issues may disrupt and impair the business operations. When a partner becomes ill, dies or sells their share of the company, it can negatively impact your business.
Buy-sell agreements serve as a continuity plan to protect you from these potential risks. This agreement indicates the responsibilities of the co-owners and how the company will continue to operate under these challenges.
Types of Buy-Sell Agreements for Your Business
When it comes to buy-sell agreements, there are three types of plans business owners can implement. You can get in touch with Save Corporation Tax to know more about your options and which suits your business structure better.
- Cross-Purchase Plan
This type of buy-sell agreement is more suitable if the business has two or three owners. With a cross-purchase plan, each owner buys life insurance on the co-owners which they will own. In case one of the co-owners die, the surviving business owner or owners become the beneficiary of the life insurance.
Once they receive the death benefits, they can use it to buy-out the share of the owner who passed away or use the payout to keep the business afloat. The structure of this plan is similar to the regular life insurance policy.
- Stock-Redemption Plan
With stock redemption, each business owner to sign an agreement with the business where each person agrees to sell their business interests to the company. This agreement replaces the need to pass the individual’s ownership to their heirs.
What happens is the company buys the life insurance, fund it, and pay the insurance premiums. The proceeds from the sale will go to the members.
- Hybrid agreement
A hybrid agreement is a combination of two types of a buy-sell agreement. This plan involves co-owners who propose their shares to the company. If the business declines your offer, the co-owners can opt to buy your shares. Meanwhile, other longtime key employees can also have the option to buy the shares.
How to Set Up Buy-Sell Agreement
A buy-sell agreement creates the rules, terms, and provisions for the heirs to reduce potential tax burdens if the successors inherit a part of the company. Here are some tips on how to set it up.
- Plan ahead
Just like any legal documents, you should set-up a buy-sell agreement early in your business. If you are starting a business with your partners, you should consider setting up this agreement as part of your business plan.
While some owners prefer to set it up later on, its always better to do it from the start and avoid delaying it. This way, the process may be easier to handle because it becomes just one of your to-do lists when you’re starting a company.
- Create some rules
This contract helps set up the ground rules for your business including identifying the heirs of your business. This type of agreement can include details of possible events that can lead to the sale of the company. This prevents lenders from controlling the company if the co-owner goes bankrupt.
- Add life insurance policies
A lot of business owners purchase life insurance for each other in addition to a buy-sell agreement. This agreement ensures that the co-owners have access to the cash needed to buy out one of the co-owners.
- Don’t forget the taxes
When you’re selling your business, one of the biggest factors that can reduce the amount is an estate tax. The same goes if your successor decides to sell their shares.
Make sure to follow a conservative valuation computation in your buy-sell agreement. Otherwise, you might end up paying unnecessary taxes.
- Include a valuation clause
The valuation clause of your company is crucial to a buy-sell agreement. It determines how you estimate the value of your stake in the businesses if you are no longer part of it.
Some companies add their own valuation policy in the agreement. These decisions should be determined by a valuation expert.
Bottom Line for Business Owners
As a business owner, you know you’ve worked so hard to achieve the level of success of your company has now. Therefore, you should set up plans on how you can protect your business in case you become disabled, sick, find yourself unable to work or die. It doesn’t make it easier for business owners to create their succession plan, especially if they have business partners they need to involve in the decisions.
Hence, creating a buy-sell agreement is a crucial step in setting things in place in your company. This helps protect your interests and create a smooth transition when transferring ownership of the business to an heir. Setting up a buy-sell agreement on the early stages of your business prevents any agreements from arising in the future.
Having a buy-sell agreement in place helps you set the rules of ownership which makes it easier for stakeholders to decide when faced with difficult decisions and situations pertaining to the transfer of ownership.
