How Buy Sell Agreements Can Protect A Small Business

Is it necessary for small business owners to put a buy sell agreement in place?

Small business owners have a number of important considerations to make even before the enterprise is launched including selecting the appropriate business structure, securing the use of a name, obtaining the necessary licenses, and completing the required state filings. In addition to these concerns, it is crucial to create agreements among the owners and partners, none the least of which is a buy sell agreement.

Buy Sell Agreements At A Glance

A buy sell agreement is designed to clarify the redistribution of ownership interests if one of the partners or owners dies. These agreements can also handle other unplanned events such as disability and bankruptcy or divorced. In short, putting a buy sell agreement in place allows the partners/owners to redeem the stake of an a deceased or departing owner.

Generally there are three types of buy sell agreements. The first is known as a cross-purchase agreement which is well suited for small partnerships or businesses with a small number of owners. In this arrangement, the remaining partners directly purchase the stake of the departing owner. Another arrangement is a stock-redemption agreement in which the corporation redeems the shares rather than the remaining owners, but the value of their shares increases.

Lastly, there are agreements that have features of both of these agreements, or hybrids which basically give the owners the option to redeem the shares when the business cannot acquire the departing owner’s interest.

How Is The Business Valued?

A well thought-out buy sell agreement will also determine the valuation of the business. The most basic method is the asset approach, which simply subtracts the liabilities from the stated assets, and does not consider good will or market conditions. Next, the income approach considers past earnings, projects future earnings, future cash flow and capitalization in order to ascertain the present and future value of the business. Finally, the market approach is an analysis of the sale of similar businesses in the same industry that considers size, how long the entities were in business, and most importantly, market risk.

The Bottom Line

Having a buy sell agreement in place is crucial to plan for an array of circumstances that can impact the business. A carefully planned agreement can help minimize conflicts among the remaining owners and provide clarity in the face of unexpected events. To ensure the continuity of your business, you are well advised to speak with a an experienced business law attorney to put in place an agreement that suits your needs.