Growing Your Business

The Importance of a Buy/Sell Agreement for Your Business

The Importance of a Buy/Sell Agreement for Your Business

Handshake agreements feel honorable and pleasantly old-fashioned. But, they are not a good idea when establishing a closely-held or a family-owned business. If something goes wrong, you need the protection of a buy/sell agreement. Here are a few reasons why this is important:

1. Buy/sell agreements give you a road map for when things go wrong.

When you are in that giddy honeymoon phase when you've just started a business, you don't want to think about problems that may be lying down the road. But, if a part-owner of a business dies, divorces or becomes otherwise incapacitated, you need an agreement that will allow you to proceed fairly. Additionally, disputes between owners often happen. The buy/sell agreement helps you govern how one or more can leave the business without causing harm to the enterprise.

2. They provide a market for shares of a closely-held business.

If one party wants to leave the business, a buy/sell agreement gives a path that can preserve the closely-held nature of the business. Buy/sell agreements usually either specify that remaining owners are required to buy the departing owner's shares or that the shares are to be purchased by the business entity itself. In some cases, a hybrid approach is used, allowing the remaining owners the chance to buy them before they are purchased by the entity. When the entity option is chosen, it is often funded with a tool like life insurance, where the business itself pays annual premiums and is the beneficiary of any policies. This ensures that the funds are there to buy a member out in case of death or permanent disability.

3. They allow stakeholders to develop an evaluation of their business.

Often, owners of a small but growing business won't think about how much the business is worth until it is time to seek outside investment or until a partner wants to sell. Waiting this long, however, can lead to headaches for all involved. The buy/sell agreement is an opportunity to look at the business's cash flow, assets and income and determine what the business is worth. It is important to remember that the value of a business can change over time. The valuation should be recalculated regularly to ensure that there are sufficient funds to buy a partner out if it becomes necessary.

4. Buy/sell orders can ensure that everyone has the funds for taxes.

If a business is organized as an S Corporation or a limited liability company, buy/sell order allows the business to allocate funds so that all owners get large enough annual distributions from the company to cover any taxes. This can be particularly valuable for new business owners and can help assure that there are no tax-time surprises.

Talking about contingencies among business partners can be uncomfortable. It can make people feel like they are not trusted to do the right thing. But, having a buy/sell agreement in place means that you can do business together without worrying about possible negative outcomes and can direct your energy toward making your business together a lasting success.

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Sherri Hastings

Sherri Hastings

Tim Murphy is the managing member at Murphy & Murphy, CPA, LLC, a full-service certified public accounting firm, with emphasis on tax preparation, audits of governmental, educational, and non-profit entities, retirement planning, estate planning, business valuations, litigation support, and banking. He is a Certified Public Accountant in Maryland and Virginia. Tim is also a CERTIFIED FINANCIAL PLANNER professional, Personal Financial Specialist, Accredited Estate Planner, Certified Valuation Analyst, and Investment Adviser Representative.

MURPHY & MURPHY, CPA, LLC.
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