Buy Sell Agreement: Protecting Owners, Families and the Business
If you share ownership of a business with partners, a buy sell agreement is one of the most important documents you may ever sign. It sets out what happens to an owner's interest if that owner dies, becomes disabled, retires, divorces, or leaves. Without one, surviving owners may end up in business with a former partner's spouse or heirs, and families may be left holding an interest they cannot easily sell or value.
A buy sell agreement is a legal document, so it should be drafted with an attorney. It is also a tax and wealth planning document. How the agreement is structured, valued, and funded can affect estate taxes, the tax basis of surviving owners, and the financial security of each owner's family.
Start Here: A Complimentary Wealth and Tax Review
Many owners signed a buy sell agreement years ago and have not looked at it since. Compound offers a complimentary, no-obligation wealth and tax review that may include:
Your current agreement: whether the valuation method and triggers still reflect the business
Funding: whether there is a realistic way to pay for a buyout if it is triggered
Tax considerations: how the structure may affect estate taxes and basis
Your personal balance sheet: how much of your net worth is tied to the business
Family and estate goals: how the agreement coordinates with your estate plan
Request your wealth and tax review.
What Is a Buy Sell Agreement?
A buy sell agreement is a contract among business owners, and sometimes the business itself, that controls how ownership interests change hands. It generally answers three questions: what events trigger a buyout, who buys the interest, and at what price.
Common triggering events include:
Death of an owner
Long-term disability
Retirement or voluntary departure
Divorce, where an interest could otherwise pass to a former spouse
Personal bankruptcy
Termination of employment for an owner who also works in the business
Common Structures: Cross-Purchase, Redemption and Hybrid
Buy sell agreements generally take one of three forms:
Cross-purchase agreement. The remaining owners agree to buy the departing owner's interest directly. One potential advantage is that buying owners may receive a higher tax basis in the shares they acquire, which can reduce gain on a future sale. With many owners, cross-purchase agreements can become complex to fund.
Entity redemption agreement. The business itself buys back the interest. This may be simpler to administer, but surviving owners generally do not receive the same basis increase.
Hybrid or "wait and see" agreement. The business and the owners decide at the time of the triggering event who will buy, which may add flexibility.
The right structure depends on entity type, the number of owners, their ages, and long-term plans for the business. These choices belong in conversations with your attorney and your tax advisor together.
How Is the Price Set?
Valuation is often the most disputed part of a buyout. Agreements typically use one of these approaches:
Fixed price, agreed to by the owners and updated periodically. Many fixed prices go stale because they are never updated.
Formula, such as a multiple of earnings or book value.
Independent appraisal at the time of the triggering event.
Each approach has tradeoffs between simplicity and accuracy. If you are unsure what your interest is worth today, read what is my business actually worth and who tells me.
How Does Buy Sell Agreement Funding Work?
A buyout that cannot be paid for may not help anyone. Buy sell agreement funding options often include:
Life insurance owned by the business or by the other owners, to provide cash at an owner's death
Disability buyout insurance for long-term disability triggers
Sinking funds or company reserves built up over time
Installment notes, where the buyer pays the departing owner or family over several years
Outside financing from a lender
Each method has different tax and cash flow effects. For example, a recent U.S. Supreme Court decision held that life insurance proceeds received by a corporation to redeem a deceased owner's shares can count toward the company's value for estate tax purposes. That decision led many owners to revisit whether a redemption or cross-purchase structure fits their situation. Insurance decisions should be reviewed with a licensed insurance professional, and agreement terms with your attorney.
Connecting the Agreement to Business Continuity Planning and Your Wealth
A buy sell agreement is a core piece of business continuity planning, but it also shapes your personal financial plan. Questions worth discussing include:
Concentration risk. If most of your net worth is in the business, how would your family be supported if a buyout paid over many years?
Estate planning. Does the agreement price align with how your interest is valued in your estate plan? Coordinate this with your estate attorney.
Income replacement. How would buyout proceeds be invested to replace income you or your family depend on?
Succession. Does the agreement work alongside plans for next generation business transition planning?
For more on the estate side, see estate and succession planning for business owners and planning for generational ownership changes.
Why Tax and Wealth Planning Should Work Together
A buy sell agreement touches legal drafting, valuation, tax structure, funding, and the long-term security of every owner's family. Compound brings wealth management, investment management, tax planning and preparation, and business transaction services together and coordinates with your attorney, so the agreement fits both your business plan and your personal wealth plan.
Compound works with business owners throughout Wisconsin, including Milwaukee, Madison, Green Bay, Appleton, Oshkosh, Sheboygan, and Janesville, as well as surrounding areas.
Ready to revisit your agreement? Request a complimentary wealth and tax review.
Frequently Asked Questions
What is a buy sell agreement?
A buy sell agreement is a contract among business owners that sets out what happens to an owner's interest after events such as death, disability, retirement, or departure, including who buys the interest and at what price.
What are common buy sell agreement funding methods?
Common methods include life insurance, disability buyout insurance, sinking funds, installment notes, and outside financing. Each has different tax, cash flow, and cost considerations.
What is the difference between a cross-purchase and a redemption agreement?
In a cross-purchase agreement, the remaining owners buy the interest directly. In a redemption agreement, the business buys it. The choice can affect tax basis, estate valuation, and complexity.
How often should a buy sell agreement be reviewed?
Many owners review their agreement every few years, and whenever ownership, business value, tax law, or family circumstances change significantly.
Who should be involved in drafting a buy sell agreement?
An attorney should draft the agreement. Tax and financial professionals can help evaluate structure, valuation, funding, and how the agreement fits each owner's estate and wealth plan.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Calculator results are hypothetical, are not guarantees of future results, and do not reflect any actual investment. Investing involves risk, including possible loss of principal. Diversification does not ensure a profit or protect against loss. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
About Compound Wealth
Long-term financial planning often involves balancing tax considerations, investment decisions, business interests, and personal financial goals. Compound Wealth provides an integrated planning approach that brings these disciplines together to provide a coordinated framework for evaluating financial decisions as financial circumstances evolve over time.
