If you are a co-owner of a business, or are considering starting a business with a partner in Alabama, developing a buy-sell agreement is a very important step to take. A buy-sell agreement (BSA) is an agreement between business partners outlining what will happen to an owner’s share in the business if they leave for some reason. Owners leave their businesses for a variety of different reasons including death, disability, retirement, or the desire to pursue a different career. Because these departures are sometimes sudden, it is very important to have a buy-sell agreement in place that dictates the terms and conditions under which the remaining owners will be allowed to purchase the leaving owner’s share of the business. Working out a buy-sell agreement when a business is first formed is a very prudent thing to do because this can help the parties involved negotiate rationally in anticipation of issues rather than emotionally after issues arise. Involving an impartial corporate law attorney who can draft the agreement and help estimate the value of the company is also a great idea. You can also achieve some of the same results within the company’s operating agreement.
Why Create a Buy-Sell Agreement?
According to USLegal.com buy-sell agreements are generally created for three different reasons:
- To establish the business’ value for death tax purposes.
- To avoid continuing the business with a deceased co-owner’s heirs.
- To prevent partial ownership of the business from falling into an “outsider’s” hands.
In order to realize these various objectives, buy-sell agreements come in several different forms. For example, a buy-sell agreement can take any of the following shapes:
- Stock Redemption Agreements or Stock Retirement Plans: These buy-out agreements are formed between the business and the individual owners.
- Criss-Cross Agreements: A buy-sell agreement between the owners of the business.
- Third Party Business Buy-Out Agreement: These buy-out agreements are formed between the business’ owners and another key person, such as a family member.
- A Combination: A buy-out agreement can also be a combination of the forms listed above.
Mistakes Commonly Made When Drafting Buy-Sell Agreements
Although buy-sell agreements are very commonly developed by closely held business owners, according to the Cannon Financial Institute there are several mistakes that are commonly made when drafting these agreements. A few of these mistakes include:
- Waiting Too Long to Draft the Agreement: It is important to draft your buy-sell agreement well before it is needed. In fact, it’s never too early for your business to develop a buy-sell plan. However, it is important to remember that a business’ needs change over time and that you may need to change provisions in the agreement at some later date.
- Using a Fixed Valuation: Buy-sell agreements often contain a fixed dollar amount that operates as a purchase price in the event that a triggering event occurs. This fixed amount will probably need to be updated every couple years as the business grows, and can be problematic as many business never actually update their buy-sell agreement.
- Inadequate Funding: New business are often low on cash, and therefore buy-sell agreements are often not funded appropriately. While life insurance policies are often used to fund buy-sell agreements, it is important to make sure that the insurance coverage is sufficient, even after the business has grown.
What Can We Do to Help?
Drafting a buy-sell agreement that meets the individual needs of your business is critical to the long-term health of your organization. Employing a law firm that has experience drafting corporate documents, such as Cloud Willis & Ellis, LLC, will help ease your mind and ensure that the future of your company is safely in order. Our corporate law attorneys are happy to assist you and can be reached at our office in Birmingham (205-322-6060) or in Mobile (251-545-4844).