Refresher: how does a buy sell agreement operate?

Buy sell agreements are often viewed as the ‘will’ of a business, enabling an owner to transfer their interest to the other remaining owners, when certain specified trigger events occur. The most common triggers contemplated in agreements are death, long term or permanent incapacity and trauma. Under the agreement, when one business owner is impacted by such an event, they consent to sell their share of the business, while the remaining owners agree to purchase that outgoing person’s interest.  

Buy sell agreements take precedence over wills that may have been executed by individual owners of the business. Agreements are generally funded by a life insurance policy on the outgoing owner. Buy sell agreements are most suited to small and medium sized businesses and are able to operate within a unit trust, partnership, proprietary companies and hybrid business structures. 

An underutilised instrument

Statistics from 2008 have shown that more than 70% of business owners in Australia have no form of written business succession plan. Even though 38% of business owners know about buy sell agreements, only 9% actually have one place. This is a startling figure, given that they are such an effective means of providing certainty for the future of a business and avoiding disputes.

In the absence of a buy sell agreement, results can be devastating. Often the consequence is that the transfer of outgoing owner’s share occurs at substantial undervalue. This may be due to inability of the remaining owners to purchase at market value, or the vulnerability of the outgoing owner who may be suffering from stress caused by the change in their life circumstances, combined with the tension produced by the business conflict. In the worst case scenario, the business may need to be wound up.

Who benefits from the existence of a buy sell agreement?

All stakeholders within the business can receive some advantage from having a buy sell agreement.

Remaining owners:

For those who remain in the business, the agreement prevents the doubt and worry of not knowing who will take on the outgoing owner’s business share. Given that the insurance policy finances their purchase, they don’t need to dig into their own pockets or borrow to finance the buy-out.

By retaining ownership within the business, it also eliminates the risk of third parties who may not be suited to joining the business from buying in, such as spouses, family members or friends, regardless of what the outgoing owner’s will may stipulate. Instead, the agreement assures viability and stability, by binding the existing co-owners who already have the necessary expertise and knowledge.

Outgoing owner:

A buy sell agreement will guarantee sufficient compensation for disposal of the departing owner’s interest. Additionally, it avoids this person feeling guilty about leaving the business for a reason that is expressed as a trigger event under the agreement, such as deteriorating health, trauma and in some cases, retirement.

Employees:

Employees are also provided with a sense of security about their employment, by this slight change of ownership which is shared amongst existing owners. Alternatively, the agreement could even offer employees an opportunity to acquire a stake in the business.

How should a buy sell agreement be funded? Gold and Platinum members can find out…

How is the value of the business calculated?

Buy sell agreements play a key role in business succession planning. They reduce the stress and unnecessary complications involved in replacing fellow business owners, ensuring the best possible outcome for all stakeholders. While there is some expense involved in taking out an insurance policy, the cost of not having an insurance funded buy sell agreement could be much more costly. Law Central has made the first step easy, by allowing you to construct a personalised buy sell agreement using our online Build a Document process.

Click here to start building your own buy sell agreement.