You start a business with two partners. You put in the long nights and early mornings. You raise capital, and spend more of your own savings than originally planned. After a few long years, it takes off!
Your business is a success. You and your partners have been handsomely rewarded for your efforts. You and the partners, and your spouses all travel on a well deserved vacation together.
As you sit on the beach one of your business partners says, "Did you hear what happened to Acme Corp? One of their partners had to close the company. One of the original partners died, and the other partner had a long term disability. I saw an article about buy-sell agreements. Maybe we should check those out?"
This is the article.
Buy-Sell agreements are legal contracts between business partners that stipulate what ought to happen in the case that one or more partners would like to buy out or sell their portion of the business.
Typically it's used as a safe-guard, and coupled with some sort of insurance policy to protect the financial interests of the partners.
Here are a few scenarios to consider drafting a buy-sell agreement, and potentially getting insurance or other plans in place in case something does happen.
1) A long term disability
Someone is actually more likely to become disabled three to five years in their lifetime than they are to pass away prematurely. Said a different way; the odds are that opposed to a 30 year old passing away, that 30 year old is likely to have some sort of sickness or illness that they survive, and then they will probably live to 80.
A buy-sell arrangement could include a portion that discusses what to do in the event that a partner is disabled, and cannot perform his or her duties as an owner/partner for more than 90 days.
Things to consider:
- Will they come back?
- Will they want to sell their portion of the business to the existing partners?
- Will they want to sell their portion to outside investors?
The part of a buy-sell agreement that covers disability could say: "In the event of a long term disability our partnership will do XYZ, and then 123…"
The key is to have it written down in contract form, because if someone's family is struggling because they can't work, money and partnerships can break down.
Oftentimes business partners will purchase disability buy-out insurance so they have the proceeds to buy one partner's percentage of the business with the insurance money, and not their own.
We all hate to talk about it, but we have to be real. Sometimes business partners die while we're still young. In a buy-sell agreement it ought to be discussed. Typical things to address:
- Who is the beneficiary of the partner's percentage? The spouse? The kids? The existing business partners?
- If a spouse or child gets the ownership, can the other partners buy their share out? With their own money? Using life insurance that was purchased on the owners?
- Who will assume duties of the deceased partner? Will you need to hire someone right away?
All of these things, while not fun, will provide a tremendous amount of stress relief and peace if planned out, and funded ahead of time with a buy-sell agreement and cross-purchase life insurance (All the partners have insurance on each other).
Other things can happen too.
- Long term care event—someone is still alive, but can't make decisions.
- Divorce—if there is a divorce does the spouse get 50 percent of the partner's assets? Is your business in that!?
- One partner is pushed out by the others—disagreements or splits.
- One or more partners want to retire or move away—natural retirements, or partners are ready to part ways.
All of these things could happen at any point. The more robust your contract, the more likely that you'll have all of these events planned out ahead of time. Hopefully the document never gets used, but that is much preferred to never being made.
So back to yourself on the beach with your partners…
What would you do?
If you have a business, or know people in business, pass this along!
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