What is a Buy Sell Agreement?
A contract that allows transfer of a business to remaining owners, if one owner is unable to stay in the business.
This may be due to death or permanent illness or disability, and is usually coupled with insurance policies to provide the funding to buy out the departing owner’s equity interests.
This can allow the remaining owner(s) to continue the business, and provided an exit compensation to the departing owner or their estate for their ownership.
There are many options for policy ownership. It can be via the individual or business or a separate structure, advice is needed here.
What should it include?
A Buy Sell Agreement should include the requirement of the individual owners or the business to take out and maintain life, trauma and/or permanent disability insurance.
The agreement should also stipulate how the insurance premiums are to be paid.
Why is it Important?
There are a number of reasons. From our experience, some of the more material ones include:
The remaining owners having to sell part of the business to pay out the exiting owner's interests; or
A departing owner’s spouse becoming an active partner in the ongoing operation of the business, where they do not have the optimal skills to do so; or
The departing owner’s interests retaining a right to claim a share of the business profits, without having to make any material contribution to the business.
Case Study - Business Owners’ Story
Nick, Tom, David and Karen are co-directors of a real estate sales and property management business. It has 45 staff and an annual turnover of $12 million.
The directors are unconvinced of the benefits of personal insurance to protect their equity in the business. They have a handshake agreement in place and believe that the business can draw on its capital should the requirement to ‘buy out’ one another arise in the future.
And then:
Nick unexpectedly passes away. Nick’s family trust owns his shares in the business, which is now represented by his wife Jenny.
Jenny wants to sell the shares and the remaining directors offer to pay $2 million for Nick’s shares. Jen requests an independent valuation and it reveals that the shares are worth $3 million.
The remaining directors cannot fund the purchase. Twelve months on, Jenny and the remaining directors are still gridlocked.
The learning:
Directors need supporting insurance policies to fund the exchange in shares in a business, and its true value is often underestimated.
An agreement could have provided for a transfer of Nick’s ownership interest to the remaining directors, whilst ensuring Jen received adequate consideration for relinquishing the equity she inherited from Nick.
More information?
Contact MCP:
E - mcpnews@mcpgroup.com.au
W -www.mcpfinancial.com.au
T - (03) 9620 2001
The team at MCP Financial Services has specialised expertise in supporting Business Owners.