If something bad happens to a business owner, such as an illness, disability or even death, his or her partners will want to make sure the business remains viable and that the owner’s loved ones benefit from the hard work put into making the business successful. At the same time, few owners want to be in business with the spouses or children of a partner who is no longer able to carry out his or her duties. Severing ties in this type of situation is best accomplished with buy/sell agreements. In fact, when a company has multiple owners and stock that is illiquid because it’s privately held, buy/sell agreements are usually a wise planning move.

A buy/sell agreement is a legal contract that:
• Ensures that when a trigger event occurs, such as the death of an owner, his or her equity in the business will be purchased and the proceeds of the sale will go to his or her heirs.
• Guarantees that funds are set aside to buy the equity if a trigger event happens.
• Provides a funding source, such as insurance, to ensure the  liquidity needs of the business and make sure that the financial demands on the remaining business owners will not be onerous
• Determines a valuation for a deceased owner’s business equity to calculate estate taxes.

The Gap
Buy/sell agreements for privately held business with multiple owners are clearly sound planning tools, but not all business owners have them. According to a Prince & Associates study conducted in 2011 of 329 privately held businesses that have been operational for 15 years or more, all with multiple owners, nearly three-quarters had buy/sell agreements.  

Death is the most common trigger event written into buy/sell agreements. In fact, few businesses with buy/sell agreements addressed situations other than death, according to the study. Other possible triggers, such as disability, retirement, divorce and bankruptcy, were largely ignored (Figure 1)—an oversight that could later hobble many business owners.

Also problematic is the fact that very few business owners have reviewed their buy/sell agreements or their funding mechanisms within the last five years (Figure 2). Meanwhile, all business owners in the survey reported meaningful changes in the fortunes of their companies, making it likely that their buy/sell agreements and funding plans are out of date.

Implications
What these findings tell us is that while many business owners recognize the need for buy/sell agreements to deal with death, very few recognize the other potential events a buy/sell agreement can address. For example, failure to deal with the possibility of a partner becoming disabled can prove disastrous for the business owners as well as the company.

It’s also evident that a large percentage of business owners are looking at buy/sell agreements, marking them complete on their checklists and forgetting about them. They understand the need for the agreement, but once they have one, they fail to keep it updated.

It’s essential for advisors to make sure the documents deliver the results the owners are looking for and provide insurance that is appropriate and cost-effective. From experience, we’ve found that agreements and their insurance contained within can usually be improved upon—often resulting in less expense for business owners. Business owners can also cut costs by incorporating creative options into the agreements, such as one-way buy/sell agreements; by making partnerships the beneficiary of insurance proceeds; and by using charitable trusts as part of the process.

Michael J. Desmond is a senior wealth management advisor for Provident Bank. He has an extensive wealth advisory background enabling him to create and implement customized solutions for the bank’s high-net-worth clientele.

Frank W. Seneco is president of Seneco & Associates, an internationally recognized advanced planning boutique. He works extensively with the very wealthy, providing life insurance and related solutions.