Earlier last week, we discussed buy-sell agreements. Since a buy-sell is simply a contract between business partners, the partners can agree on the triggers that will force one business partner to buy out the other partner’s share. Here’s a brief explanation to help detail some of those triggers.
In Louisiana, a community property state, if a co-owner of a business divorces, the former spouse may ask for part ownership in the business. This is because all earnings during marriage and all property acquired with those earnings are owned equally by the husband and the wife. When property, such as stock or ownership rights in a company, is divided during a divorce, each spouse can claim a right to the business.
To avoid this prospect, a good buy-sell agreement requires the former spouse of a divorced owner to sell any interest received in a divorce settlement back to the company or the other co-owners. The spouse will actually have to sign off on this agreement and become a party to the contract. This should be arranged in accordance with a valuation method provided in the agreement.
It is always a possibility that the trustee in a bankruptcy matter could liquidate business assets and use the bankrupt co-owner’s percentage to pay for his/her debts. Buy-sell agreements are used to prevent a business from getting stuck in bankruptcy court. As a matter-of-fact, the co-owners can draft a clause that requires any owner that is considering bankruptcy to notify other the other co-owners before filing. Most agreements include an automatic offer to sell the bankrupt owner’s interest back to the other owners. The buyout money will go to the bankruptcy trustee to satisfy the bankrupt former owner’s debts.
A buy–sell agreement secured by life insurance guarantees that there will be money when the buy–sell event is triggered by death of a co-owner. This method is faithfully recommended by business-succession specialists and financial planners to ensure that the buy–sell arrangement is well-funded.
Buy-sell agreements have also been utilized to help lower estate taxes in family businesses where at least one co-owner plans to leave the interest to heirs who will remain active in the business. This can help a family business owner pass the business on to children or other relatives without the burden of unnecessary estate taxes caused by the overall value of the business.