Succession Planning for Small Business Owners, Part 2:
The Buy-Sell Agreement
Our previous article on succession planning noted that as a business owner, your ultimate
long-term success can only be established at the very end of the day, when you sell your
business, retire, or leave the business for reasons of death, disability, or economic
circumstances beyond your control. To maximize the likelihood of achieving the kind of
success that you and your family want, need, and deserve, there are many important
considerations, including ownership structure, long-term value drivers, and appropriate tax,
insurance, financial, legal, and contingency planning. But for those who are not the sole
owners of their business—for those whose business is an LLC with other members, or a
corporation with other shareholders, or even an old-fashioned partnership with other
partners—probably no document is more critical to long-term success than a buy-sell
agreement.
Also known as a “buyout agreement,” a “business will,” or even a “corporate prenuptial
agreement” (because like a marriage, a business is often easy to get into but very hard to
get out of), a buy-sell agreement spells out, among other things:

Who can (and in some cases, who must), and who can not, buy a departing owner’s
share of the business;

What events will trigger a buyout, including, for example, death, disability,
retirement, or an outsider’s offer to purchase a co-owner’s interest;

What price will be paid for a shareholder’s, member’s, or partner’s share of the
business; and

How any buyout will be funded, which usually and most effectively takes place
through life or disability insurance either cross-held by the owners on each other or
held by the business entity itself.
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As Important As They Are Potentially Problematic
With a buy-sell agreement in place—especially one adequately funded through
insurance—many potential unknowns are eliminated, thereby making long-term financial
planning for everyone involved much more feasible. For example, a buy-sell agreement
can provide a liquid market that might not otherwise exist for the shares of or membership
interests in a business. And with a buy-sell agreement in place, you can rest assured that
you will not have to be in business with the inexperienced spouse or children of your nowdeceased partner.
Alternatively, without a buy-sell agreement, matters can rapidly become adversarial and
chaotic, with the parties being forced to rely on generic state law statutes and courtroom
proceedings to bring matters to an ultimate conclusion. Given that a death or disability of a
co-owner already is an emotionally difficult time, and given that the business may have
lost key operating expertise and knowledge, the last thing anyone wants in these
circumstances is a protracted, expensive, legal battle. Also, the existence of a buy-sell
agreement can be particularly valuable for those who hold a minority interest in a business,
and may otherwise be at the mercy of those who hold the majority interest.
What makes buy-sell agreements inherently problematic, however, is that to do one
“right”—to thoroughly assess the desires of the various owners and then come up with a
binding agreement that does the best possible job in meeting everyone’s concerns both
now and in the future—often takes a great deal of work. That is, while buy-sell agreements
are somewhat simple in concept—“If one of us leaves, for this or that reason, here’s what
we’ll do with the ownership interests and how we’ll pay for and handle the transfer”—they
are actually among the more intricate and labor-intensive agreements that business lawyers
typically craft. So while the optimum time to really think through and craft a thorough and
fair agreement is when a business is being created, that’s just when the resources and
attention needed to create such an agreement are often hard to come by.
8440 SW Canyon Lane
Portland, OR 97225
www.cfgwealth.com
7 Rules of Thumb
Since buy-sell agreements are simple in concept but often very tricky to flesh out, this
section sets out a series of 7 Rules of Thumb (R.O.T.) that will help summarize some of
the most important factors and help orient you in the right direction. Some of these Rules
of Thumb are more appropriate to those who are just creating a business with multiple
owners, others to those who already have such a business and do not yet have a buy-sell
agreement, and others to those who already have a buy-sell in place and need to keep it
updated and relevant. The point here is to raise your awareness as to the general
considerations that you should keep in mind, and in the conclusion to this article we’ll
consider the advantages of working with an experienced wealth manager in terms of
creating or updating your buy-sell agreement.
R.O.T. # 1: If you are a co-owner of a substantial business, then having a buy-sell
agreement is a necessity, not a luxury; without one, effective realistic long-term
personal financial planning is nearly impossible, and eventually you or your heirs
may find themselves in a world of pain and expensive, rancorous, litigation.
R.O.T. # 2: While the best time to put a buy-sell agreement in place is when
your business is being formed, it’s never too late, and if you don’t have one it
should become a top priority. (While an LLC’s operating agreement or a
corporation’s bylaws may sufficiently cover the same ground that a buy-sell
agreement covers, this is the rare exception.)
R.O.T. # 3: Ideally guided by a trusted financial advisor, work closely with an
attorney, accountant, and insurance agent to make your buy-sell agreement as
simple, clear, and fair as possible, both so that if and when a triggering event
(death, disability, retirement, etc.) occurs, everyone involved will know just what
needs to happen and will comply, and also because you can’t be sure whether you
(or your heirs) will be on the “buying” or “selling” side of things.
8440 SW Canyon Lane
Portland, OR 97225
www.cfgwealth.com
R.O.T. # 4: Buy-sell agreements that are funded by insurance are highly
preferable, because the money needed to buy a co-owner’s interest once a
triggering event occurs is rarely readily available in liquid form (in the business
itself or in the accounts of the other owner or co-owners); to convince yourself of
the advantages of funding the buy-sell through insurance, ask an insurance agent to
sketch out some scenarios comparing the costs of paying for insurance premiums
versus coming up with the cash to buy your co-owner’s interest. Note that while
you can decide to self-insure, this should not be done out of ignorance, and in most
cases a review of the different scenarios involved in a funded versus a non-funded
buy-sell agreement will rapidly and readily convince you of the tremendous
advantages of the former.
R.O.T. # 5: It’s best to work closely with an insurance agent, an accountant,
and an attorney in terms of funding a buy-sell agreement because there are a
number of different options in terms of what type of insurance to buy and who
will hold the insurance policy, including each owner holding a policy or policies
on the other owners (which can become very complex if there are multiple owners),
the business itself holding the policy, a mixture of the business and the owners
holding the policy, and the creation of another entity (such as a trust) to hold the
policy, all of which have different tax implications.
R.O.T. # 6: While it’s rare to have a buy-sell agreement state that insurance or
some other mechanism must be used to fund the agreement, it’s a very good idea
for the agreement to state that all insurance proceeds that are available on an
insured person’s life must be used immediately to purchase the available
interest after a triggering event, either as payment in full or as a down payment
along with a work-out over time.
8440 SW Canyon Lane
Portland, OR 97225
www.cfgwealth.com
R.O.T. # 7: It’s best to work closely with a wealth manager, an accountant, and
an attorney in setting the price for the value of the business and buying out an
owner’s share because there are many different ways of doing this, including
setting a fixed price, using one of several different business valuation formulas to
set a price, and relying on one or more appraisers; if a specific price is set in the
buy-sell agreement, it should be reviewed on an annual or two-year cycle, and then
if insurance has been purchased to fund the buy-sell agreement, the amount of
insurance should be adjusted to reflect any change in price.
How Working With An Experienced Wealth Manager Can Help
In “Wealth Management for Business Owners: An Introduction,” the very first article in
this series, we presented an overview of the many advantages you, as the owner or coowner of a business, receive from working with a trusted and experienced wealth manager.
By assisting you with both business and personal/family financial planning, by steering
you in the right direction with respect to legal, accounting, and insurance needs and
potential problems, and by helping you address issues that are specific to businesses, you
are freed up to do more of what you do best, that is, run a successful business. One such
issue specific to businesses is selecting and maintaining the right retirement plan, as we
discussed in detail in another previous article, and another is business succession generally
and buy-sell agreements in particular.
While this article covered some of the basics of buy-sell agreements, it really only
scratched the surface. If you are working with a wealth manager, he or she will be able to
help you identify the individual circumstances relating to you and your co-owners that
should be considered when crafting your buy-sell agreement. Further, a good wealth
manager will be able to introduce you to both an attorney and to an insurance agent who is
experienced in buy-sell agreements. These experienced professionals, especially if they are
guided by a wealth manager who knows you well, will help make sure that the buy-sell
agreement fully addresses your particular situation and circumstances. In many cases, a
good wealth manager working in tandem with an experienced attorney and insurance agent
8440 SW Canyon Lane
Portland, OR 97225
www.cfgwealth.com
will be able to help you identify “standard solves”—that is, common buy-sell agreement
clauses that might directly address some or most of your needs, thereby saving you time
and money in the long-run.
Ultimately, a good wealth manager will help you not just with arriving at the right buy-sell
agreement, but with committing to do whatever it takes to come up with one that you (and
your co-owners) can sign off on in the first place. Just keep in mind that without a buy-sell
agreement, long-term personal financial planning for you and your family will typically be
difficult and unreliable, if not impossible. So while a buy-sell agreement may seem like a
daunting undertaking, it is an absolutely critical element for any successful business with
co-owners. Fortunately, the process of arriving at the right one can be greatly streamlined
by working with a wealth manager who can both identify your individual needs and can
help you identify and efficiently work with the right attorney and insurance agent.
[The author wishes to thank Jim Pittman, of Insurance Consulting Services, Inc., see
http://www.icsltc.com/?TID=176&CWID=26, and Laura E. Vaught, Esq. and Joseph D.
McDonald, Esq., of Smith, McDonald & Vaught, LLP, see http://smvllp.com, for their
time and their valuable insights into buy-sell agreements.]
Dave Pullin offers Securities and Advisory Services through Commonwealth Financial Network, Member
FINRA/SIPC, a Registered Investment Adviser. He is located at 8440 Southwest Canyon Lane, Portland,
OR 97225 and can be reached at (503) 222-7100.
8440 SW Canyon Lane
Portland, OR 97225
www.cfgwealth.com