A buy-sell agreement is a legal contract between the owners of a business that outlines how the ownership interests of the business will be transferred in the event of one of the owners' death, disability, retirement, or other unforeseen event. Buy-sell agreements are important for a number of reasons, including:
- They provide a way to ensure that the business can continue operating smoothly in the event of an ownership change.
- They can help to prevent disputes among the owners about the future of the business.
- They can provide liquidity for the owners' families in the event of an unexpected death or disability.
- They can help to minimize the tax consequences of an ownership change.
There are two main types of buy-sell agreements: standard buy-sell agreements and cross-purchase (crisscross) agreements.
Standard buy-sell agreements
In a standard buy-sell agreement, the business itself is the buyer of the ownership interest of the departing owner. The business typically pays for the ownership interest with cash or with a note. The advantages of a standard buy-sell agreement include:
- It is relatively easy to set up and maintain.
- It can be used in businesses of any size.
- It can provide liquidity for the owners' families in the event of an unexpected death or disability.
The disadvantages of a standard buy-sell agreement include:
- The business may not have the cash or credit necessary to purchase the ownership interest of the departing owner.
- The business may be forced to sell assets in order to raise the necessary funds.
- The business may be subject to double taxation on the sale of the ownership interest.
Cross-purchase (crisscross) agreements
In a cross-purchase (crisscross) agreement, each owner of the business purchases the ownership interests of the other owners. For example, if there are three owners, each owner would purchase the ownership interests of the other two owners. The advantages of a cross-purchase (crisscross) agreement include:
- It can provide liquidity for the owners' families in the event of an unexpected death or disability.
- It can help to minimize the tax consequences of an ownership change.
- It can help to prevent disputes among the owners about the future of the business.
The disadvantages of a cross-purchase (crisscross) agreement include:
- It can be more complex to set up and maintain than a standard buy-sell agreement.
- It can only be used in businesses with a small number of owners.
- It can require the owners to purchase life insurance policies on each other, which can be expensive.
Which type of buy-sell agreement is right for your business?
Buy-sell agreements are an important tool for business owners. They can help to ensure that the business can continue operating smoothly in the event of an ownership change, prevent disputes among the owners, and provide liquidity for the owners' families in the event of an unexpected death or disability. If you are a business owner, you should consider having a buy-sell agreement in place.
The best type of buy-sell agreement for your business will depend on a number of factors, including the size of your business, the number of owners, your financial resources, and your tax situation. If you are unsure which type of buy-sell agreement is right for you, you should consult with the attorney at Marlowe Law about what is best for your specific situation.