Understanding Buy-Sell Agreements: A Crucial Component of Business Continuity

Running a successful business in Sacramento isn’t just about the daily hustle—it’s also about planning for your future. While it’s easy to get caught up in the demands of today, have you stopped to think about what would happen if a partner suddenly left, passed away, or needed to exit the company? Without a plan in place, it could mean uncertainty, legal battles, or even the loss of control over your own business.

If you haven’t given much thought to your company’s future, you’re not alone. In fact, recent statistics reveal that less than 25% of private companies have a formal succession plan in place. For those without a strategy, a buy-sell agreement may be a good place to start. 

Always Consult With an Attorney To Determine if a Buy-Sell Agreement is Right For Your Business

A buy-sell agreement, also known as a buyout agreement, is like a business prenup. It’s a legal contract that outlines how an owner’s share will be handled if life throws a curveball—whether it’s a death, disability, retirement, or even a divorce. By laying out a clear roadmap for ownership changes, these arrangements can help maintain business continuity and reduce the risk of disputes.

As with any legal contract, always consult with an attorney when deciding what’s best for your company. While these arrangements can help lower uncertainty, the recent Supreme Court ruling in Connelly v. U.S. has added new considerations for companies using life insurance policies to fund a buy-sell agreement. In its verdict, the Court determined that the life insurance proceeds must be included in the company’s estate value for tax purposes. As a result, owners should always seek legal counsel to understand exactly how the new laws may impact estate planning.

Types of Buy-Sell Agreements In a Sacramento Business Succession Plan

Recognizing the different types of buy-sell agreements can help you make the right choice for your organization. The most common options include:

Cross-Purchase Agreement
Under this arrangement, you and your partners each take out life insurance policies on each other. If something happens to one of you, the remaining owners can use the insurance payout to buy the departing partner’s shares. 

Entity-Purchase Agreement
In an entity-purchase setup, the business holds life insurance policies on each owner, enabling it to buy back shares when necessary. This approach centralizes the buy-sell process to help streamline ownership transitions. However, as already mentioned, owners should discuss recent tax implications, such as those introduced in Connelly, with an attorney and tax professional to confirm that estate tax liabilities still align with prior expectations.  

Hybrid Agreement
Can’t decide between the two? A hybrid agreement gives you the flexibility of both options. Depending on the situation, the remaining owners or the business itself can step in to purchase the shares. It’s like having a Plan A and Plan B, just in case. For example, a wait-and-see arrangement is a type of hybrid where the buyer of the business interest is not identified. Instead, when the time comes, the buyer could be the entity, the other owner, or both. 

Benefits of a Buy-Sell Agreement 

Establishing a buy-sell agreement offers several critical benefits for partners and co-owners, helping to: 

Ensure Business Continuity
A buy-sell agreement can mean fewer headaches during tough times. With a clear plan for ownership transitions, your company can keep moving forward. 

Maintain Control of the Business
Without a buy-sell agreement, you could end up with a new, unwanted business partner—whether that’s a family member of your former partner or an outside investor. A buy-sell agreement can help prevent your business from falling into the wrong hands.

Provide Financial Security
With life insurance or other funding methods in place, you won’t have to scramble to come up with the money to buy a departing partner’s shares. The funds are there when you need them, avoiding financial strain on you and the business.

Clarify Valuation
A buy-sell agreement locks in a fair method for valuing the business. This valuation helps eliminate any messy disagreements over how much an owner’s share is worth when the time comes to buy them out.

Reduce Partner Conflict
Let’s face it—business relationships can get tricky, especially when emotions are involved. A well-drafted buy-sell agreement takes the guesswork out of tough situations and reduces the chances of disputes, keeping your focus where it belongs: on running the business.

Steps to Implementing a Buy-Sell Arrangement For Your Business

Once you’ve consulted with an attorney and determined that a buy-sell agreement makes sense for your company, next steps may include the following: 

Discuss with Co-Owners
Get your partners on board with the plan. Have an open conversation about the importance of protecting the entity’s future and why a buy-sell agreement is crucial.

Determine Triggering Events
What will trigger the agreement? Death? Disability? A partner deciding to call it quits? Make sure everyone is clear on what events will activate the buy-sell agreement.

Choose the Agreement Type
Select the most appropriate type of buy-sell agreement (cross-purchase, entity-purchase, or hybrid) based on your business structure and needs.

Establish Valuation Method
Agree on how the business will be valued when a triggering event occurs. Your valuation could involve a fixed price, formula, or independent appraisal.

Figure Out Funding
Life insurance is a popular choice, but you can also consider other funding options like cash reserves or loans. Whatever works best for your business, just make sure the money will be there when you need it.

Understand Tax Implications
Before finalizing the agreement, talk to a tax expert to make sure you know the implications of the buy-sell arrangement.

Draft the Agreement
Work with your lawyer to draft a comprehensive, legally binding buy-sell agreement that clearly outlines the plan and protects everyone involved.

Review and Update Regularly
Your business evolves, and so should your agreement. Review and update it regularly with your attorney to ensure it stays aligned with your current goals and circumstances.

Contact Capital Wealth Planners

Every business is unique, and your success planning should be, too. If you’re unsure where to start or have questions, Capital Wealth Planners can help you create a tailored plan that helps support your company’s future. Schedule a free consultation with our team today to start planning for tomorrow.

Investment advice offered through Capital Wealth Planners, an investment advisor able to provide investment advice in states where it is registered, exempt, or excluded from registration.  Content contained herein should not be construed as an offer or solicitation for investment advice or for the purchase or sale of any security, insurance, or other investment product.  Investments involve the risk of loss, including possible loss of principal.  Please consult with a qualified financial, tax, accounting, or legal professional before implementing any ideas or strategies discussed here.  Content provided is obtained from sources believed to be reliable but cannot be guaranteed as to its accuracy or completeness.