Most people do not really understand what a small business buy sell agreement is.
A simple question. - Do you want to retain control of your small business in the event that an existing business partner dies or are no longer in a position to fulfill their position – e.g. disability?
Let’s take an example. Peter and Paul have been in business as business partners for the last 5 years. The business they started has been hard work but the business has been profitable and is worth about $500,000 on 1 January 2013.
On 1 January 2013, Peter suddenly dies. As work was split equally between the two, Paul is now under extreme pressure and deadlines are missed and some work is lost. Paul has had to employ new staff, supervise them and train them. This has resulted in profits falling and cash flow to become tight. The business is now worth about $400,000.
The executors of Peter’s estate inform Paul that as at 1 January the business was worth $500,000 and they would like Paul to pay Peter’s estate $250,000 (50% of $500,000 being Peter’s share of the business). Paul does not have $250,000 to purchase 50% of the business and is unable to pay Peter’s estate. Remember the business is now only worth $400,000.
Peter’s executors have two options:
1. They sell Peter’s 50% to anyone who is willing to buy his share in the business. This is not good for Paul as he now has a new partner – someone he does not know and may not like.
2. Peter’s executor’s decide that his spouse will become Paul’s new business partner. This may not be good for Paul as Peter’s spouse may not know much about the business and may have different ideas on how it should be run.
A small business buy sell agreement can solve this problem.
A Buy and Sell Agreement creates clearly enforceable legal rights and obligations that are binding on both parties should an event as above occur.
How does it work?
Paul & Peter undertake to maintain personal income protection and life insurance policies for their key person. This can be paid by the business.
When Peter or Paul retires, dies, or suffers a disability illness that renders them unable to fulfill their position the surviving party will have the option to purchase the exiting party’s share in the company using the proceeds of the insurance monies received.
Do I/we need it?
Small business buy sell agreements simplify the task of deciding who will run the company when one party is no longer able to. It minimises unwanted involvement in the company from third parties (spouse of the survivor or an unwanted partner). The Agreement also provides the surviving party with funds to retain control of the company.
We would recommend a Buy and Sale agreement in any situation where there are two unconnected business partners.
Losing a business partner is a very stressful time for any business. For the surviving business partner finding capital will add to the stress levels.
All circumstances are different so you should speak to your advisor before you take any action.