Trigger events in buy-sell agreements: what events prompt the buy-out?

• Author: Bannon, Mel B.
• Position: CONSULTANT'S CORNER

An effective buy-sell agreement just makes good business sense. Closely held businesses, especially multi-owner corporations and partnerships, need to have this succession protection plan in place. Individually owned businesses can also profit from the use of a buy-sell agreement. This is essential for smooth transition of ownership upon the occurrence of several events.

Most business owners think of only one event--death. Since none of us like to face our own mortality, business owners often procrastinate in dealing with succession planning. There are other statistically more likely events that a properly structured Buy-Sell Agreement can address. We'll discuss each one individually in the corporate context; however, this also applies to partnerships and LLCs. In a single-owner business, the buyer could be a key employee(s), a business competitor, a supplier/vendor, or even a customer.

Death of a shareholder: In the event of death of an owner, the business can suffer a financial setback (key person loss). This problem can be compounded if the surviving shareholders have to take in a new partner, the deceased owner's spouse. He/She may have very little knowledge of the business, yet expect a salary and profits from the business. Harmonious transition of the business can be accomplished with a buy-sell agreement fully funded with life insurance coverage to cover the expected length of time the shareholder will remain in an ownership position. The economics for the use of life insurance as compared with funding the buyout from profits following the loss of a key shareholder are generally quite commanding, as compared with using future business profits or personal funds.

Disability of a shareholder: While most buy-sells take into account death (even though the agreement value may be low or underfunded), many totally ignore what could be a more serious financial drain--disability. Quite often, disability is poorly defined in the buy-sell document (if at all) and not funded or underfunded. A disabled shareholder would expect his/her salary to continue, as well as to get a share of profits. If the disability was extended, how long could the business keep paying? All of these decisions should be outlined in the agreement. This should be a business decision based on previously agreed-upon terms, not on emotions or personal finances at the time of a disability. And, of course, the disability agreement needs to be fully funded with Disability Buy-Out...