Business Owners
Business Partners Need a Plan for the Uncomfortable Conversation
What happens to the business if a partner dies, becomes disabled, or wants out? The time to answer that question is before it becomes urgent.
The conversation most partners avoid
Business partners spend a great deal of time planning for growth, managing operations, and navigating client relationships. They spend very little time planning for what happens if one of them dies, becomes permanently disabled, wants to retire, or simply wants out. These scenarios are uncomfortable to discuss, which is why most partnerships do not have a formal plan for them. The absence of a plan does not prevent the scenarios from occurring — it just ensures they are handled badly when they do.
What a buy-sell agreement does
A buy-sell agreement is a legally binding contract between business partners that defines what happens to an owner's interest in the business upon a triggering event — death, disability, retirement, voluntary exit, or divorce. It establishes who can buy the interest, at what price, and on what terms. It prevents a deceased partner's spouse from becoming an unwanted co-owner. It prevents a disabled partner from being stranded with an illiquid interest in a business they can no longer run. It gives the remaining partners a clear path forward. This is a legal document that requires an attorney to draft properly.
Valuation: the hardest part
The most contentious element of a buy-sell agreement is usually the valuation method — how the business will be valued when a triggering event occurs. Common approaches include a fixed price (updated periodically), a formula based on revenue or earnings, or an independent appraisal. Each has advantages and drawbacks. A fixed price that is not updated becomes stale. A formula may not capture the full value of the business. An appraisal is accurate but slow and expensive. The right approach depends on the nature of the business and the relationship between the partners.
Funding the agreement
A buy-sell agreement is only as useful as the funding behind it. If a partner dies and the surviving partners do not have the cash to buy out the estate, the agreement is unenforceable in practice. Life insurance is the most common funding mechanism for death-triggered buyouts — the business or the partners own policies on each other's lives, and the death benefit provides the capital for the buyout. Disability buyout insurance serves the same function for disability-triggered events.
The two structures
Buy-sell agreements are typically structured as either a cross-purchase agreement — where each partner owns a policy on the other partners — or an entity purchase (redemption) agreement — where the business owns policies on each partner. Each structure has different tax implications, particularly for the surviving partners' cost basis. The right structure depends on the number of partners, the ownership percentages, and the tax situation. An attorney and a financial planner should be involved in the design.
A buy-sell agreement is the plan for the scenarios that partners do not want to think about. Having one — and funding it properly — is one of the most important things business partners can do for each other.
If you have a business partner and no buy-sell agreement, that is a gap worth addressing. A financial planner can help you think through the structure before you engage an attorney to draft it.
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