Does Your Business Continuity Agreement Protect You And Your Company?
Imagine, on the eve of your wedding, that you plan to divorce, on a friendly basis of course, in 15 years or so. During those 15 years, you will work diligently, and quite successfully, to build a business.
On the preordained day that your marriage ends, you announce that you are willing to give your soon-to-be ex-spouse one-half of your company’s business value—in cash. And you let your “ex” value your company because those are the terms of the agreement the two of you signed a year after you were married.
Sounds ridiculous, right? Yet, many business owners have done something quite similar (and similarly ridiculous) in business with their co-owners.
Few owners begin working together with an expectation of future acrimony, much less litigation. Fewer still give thought to one day leaving the business—even on friendly terms. Indeed most transitions are not precipitated by a disagreement among co-owners; instead owners leave for a variety of reasons and simply want to do so with their share of business value.
And remember, one day you will leave your business.
Over time, in business as in marriage, partners can grow apart. We’ve all witnessed the resentments, discord, and wastefulness of a friend’s or acquaintance’s needless nasty divorce. Business divorces can be equally unpleasant—with an added twist: One may be unable to leave the business, or force a partner to leave, without appropriate tax and legal planning.
When you or a co-owner wants out, what will happen? Chances are that when you turn to your company’s buy-sell agreement, you will find that it is woefully out of date. You may also find that it controls the terms of your (or any owner’s) exit from the business not only upon death, but also during lifetime.
If you haven’t looked over your company’s buy-sell agreement since you signed it, dust it off and check out at least four key provisions:
|1.||Lifetime and death transfers of ownership:|
|• When must an owner sell, or offer to sell?|
|• When must an owner (or the company) buy and when does it have the option to buy?|
|2.||How will the value of the company and the value of a departing owner’s interest be determined?|
|3.||Does the agreement mandate the use of an independently determined Fair Market Value at the time of transfer? If not, the valuation will favor you or the other owner. It will not treat you even-handedly.|
|4.||What are the terms (length, down payment, interest and guarantees) of the buyout?|
We generally assume that buy-sell agreements control the transfer of an owner’s interest when he or she dies or becomes disabled. Indeed, they do that. But they usually do much more and if you don’t appreciate how much more, disaster looms.
Your first step toward avoiding the problems described in this article is to conduct a thorough review of your business continuity agreement. If you would like a more extensive checklist as well as additional information about this most important of all business documents, please contact us.
DISCLAIMER: The information contained in this article is general in nature, is not legal advice and utilizes information from Business Enterprise Institute, Inc. For information regarding your particular situation, contact an attorney or tax advisor. This newsletter is believed to provide accurate and authoritative information related to the subject matter. The accuracy of the information is not guaranteed and is provided with the understanding that none of the providers of this newsletter, including Business Enterprise Institute, Inc., is rendering legal, accounting or tax advice. In specific cases, clients should consult their legal, accounting or tax advisors.
The example provided is hypothetical and for illustrative purposes only. It includes fictitious names and does not represent any particular person or entity.
Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS under circular 230, we inform you that any U.S. Federal tax advice contained in this communication, unless otherwise specifically stated, was not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing, or recommending to another party any matters addressed herein.
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