Letâ€™s talk about the impact your death would have on your company because death is what owners usually think of when they hear “business continuity” or “buy/sell agreement.” Most of us will leave our businesses by walking out of the door, rather than by being removed by the grim reaper. Strong business continuity agreements address a variety of lifetime exits as thoroughly as they do the death of an owner. A buy sell agreement can cover many other transfer events, such as:
- Dispute between or among owners leading to sale of ownership;
- Termination of employment by Company;
- Sale to an outside party;
- Involuntary transfer due to Bankruptcy or Divorce Decree;
- Permanent disability;
Each of these lifetime transfer events can trigger either an optional or a mandatory sale or purchase. The transfer event may also not trigger any right or obligation because the event is not one that the owners have chosen to include in the Agreement. As you design a buy/sell agreement for your company, carefully consider whether each transfer event should be included and if so, whether the departing owner or the remaining ownership must or may buy or sell ownership interest. The Agreement you draft will likely have extremely important future consequences because it will govern your ability to transfer ownership on your terms or to acquire a departing ownerâ€™s interest in an affordable manner. The buy/sell agreement may be the most important business document you ever enter for these and less obvious reasons:
- Valuation standards and the IRS require that the value of the ownership interest transferred under each event be consistent. For example, the method of valuation used in a death buy-out funded by life insurance and the valuation method used to purchase a departing ownerâ€™s stock during his lifetime must be the same.
- The buy/sell agreement typically requires the same per share value to be used regardless of the event triggering the transfer. Letâ€™s assume that there are two equal owners of a business valued at $8 million. If one owner dies, his interest is valued at $4 million. Assuming that proper planning has taken place, the company or the surviving owner has acquired insurance on the deceased ownerâ€™s life in at least the amount of the value of the deceasedâ€™s interest in the company. The survivor then pays the decedentâ€™s estate $4 million and becomes the owner of the entire business.
- Most buy/sell agreements contain mandatory provisions requiring each owner to sell his ownership to the surviving owner or to buy the ownership of a deceased owner. This design works well at the death of the first owner as that ownerâ€™s estate receives the full value of his interest. It works equally well for the surviving owner provided he purchased adequate life insurance on the decedent.
What happens if your co-owner doesnâ€™t die, but, instead, wants or needs to sell her ownership during her lifetime to you? Perhaps she decides to retire or her husband files for divorce. In these cases, the obligations of each party to the other take on particular importance because lifetime transfer events are seldom fully, or even partially, funded. Fortunately, most owners will leave their businesses during their lifetimes. Unfortunately, little thought and planning is devoted to these exits despite the fact that they require more planning. In some ways, dying is the easier exit path. Next week we will examine the questions you must consider as you design a business continuity plan to handle important lifetime transfer events. When you consider what a successful lifetime ownership transition holds, it will be far more meaningful to you than a successful death transition.