Buy-Sell Agreement: A Necessary Part of Every Small Business Owner’s Succession Plan
How comfortable would you be with your spouse inheriting your small business? Or, how comfortable would you be with your children inheriting your small business? Are you confident that your business partner or partners would not fight in an attempt to buy the share from your spouse and/or children?
Unfortunately, without proper small business succession planning, this is exactly what is going to happen. Let me tell you about clients of mine. We will call them Jim and Jane Doe. Jim owned a successful small business with his business partner Bill. Both Jim and Bill owned the business as 50/50 owners. The business was worth approximately $15 million. Unfortunately, Jim and Bill never planned a proper succession plan, and Jim died unexpectedly one day.
The result was that Jim’s 50% share in the business was inherited by his wife, Jane, as directed in Jim’s Last Will and Testament. Unfortunately, there was no proper plan for the succession of the business, and Jane was not interested in stepping into Jim’s shoes to run the business with Bill. Also, none of Jim’s three children were interested.
Jane wanted to sell the interest in the business and Bill wanted to buy. Although this was an ideal situation, the business was worth $15 million, and Bill did not have the assets available to commit to a $7.5 million purchase of Jane’s share. Therefore, they were stuck. Jane was not interested in financing the buy-out with Bill and have Bill pay off the $7.5 million purchase price over the next 15 to 20 years.
Furthermore, Bill was not able to obtain the financing necessary from a bank to finance the $7.5 million purchase price. The result was that Jane sought out third-party buyers and eventually sold to a buyer for the $7.5 million asking price. Bill did not like the buyer who bought Jane’s old share, the business suffered, and Bill eventually sold his share in the business for $4 million.
In the end Jane and Bill never spoke again, and there were damaged family relationships as a result.
How a Buy-Sell Agreement helps
Jim and Bill could have avoided this scenario from playing out with a proper succession plan for the business including a Buy-Sell Agreement. This agreement would plan for the contingency regarding Jane’s share of the business that she would inherit in the event of Jim’s death.
This agreement would say that in the event of Jim’s death, Jane would have an obligation to first offer the business for sale to Bill before offering the sale to outside third-party buyers. In addition, Jim would obtain an insurance policy with a death benefit in the amount of half of the value of the business, in this case, $7.5 million. Bill as a 50% owner in the business would be named beneficiary.
The result of this arrangement would be that in the event of Jim’s death, Bill would be provided with a $7.5 million death benefit to be paid over to Jane for the 50% share of the business that she inherited from Jim. In the end, Bill would have the liquid assets available to purchase Jim’s share. Jane would have the further peace of mind that she would not inherit the business and would not have to deal with a complicated sale.
Furthermore, Jane would have the additional security of a life insurance policy that would be paid out to her in exchange for her husband’s 50% share of the business. This type of arrangement would have avoided the problems that Jane and Bill ran into.
As you can see, this is a beneficial reason to have a Buy-Sell Agreement in place between business partners and to have a customized succession plan for the business. However, this is not the only reason to have a business succession plan in place. Some other common reasons might include divorce of one of the business partners, personal bankruptcy of one of the business partners, and retirement of one of the business partners with a smooth transition of an adult child or outsider to take over the retired business partner’s share of the business.
For more information
If you have questions or concerns regarding the proper comprehensive estate plan for your family to ensure a smooth transition of your wealth to the next generation and of your business, then please contact our office for a complimentary visit and conversation, so we can discuss your estate planning needs.
We look forward to hearing from you!