Fund your small business buy-sell agreement with life insurance
Along with a general agreement about ownership and responsibilities, every business with multiple owners needs a buy-sell agreement. It covers how and when an owner can sell shares and at what price. The agreement should be signed before the business is started, but if you neglected to do so, do it now. Without a buy-sell, angry partners usually end up in court, and the business usually ends up wrecked. If you don’t have one, it is incredibly difficult to negotiate when something goes wrong.
The buy-sell should specify triggers that will set the agreement in motion. If an owner retires, for example, you may not want to allow him to continue to hold his shares. If an owner gets divorced or declares bankruptcy, you want to protect the business from the spouse and the courts. If an owner dies, you may want his shares to be sold to existing owners rather than passed to his three-year-old. (The company often takes out life insurance on each partner, so it can purchase the shares of a deceased partner if necessary.)
The buy-sell may also have a drag-along-and-tag-along provision. It specifies that if the majority owner or owners (“majority” should be defined in the agreement) want to sell to a third party, they can force the sale of minority owners. On the tag-along side, it promises minority owners the same proportionate price as majority owners in a sale. These are very important, because they affect the marketability of a company. The buy-sell should give a formula for valuing shares to ensure a fair price for a departing owner.
You may choose a clause stipulating that one partner can offer to buy out the other at a price he chooses. The other must then accept the sale or buy the company for the same price. Since this can favor the wealthier partner, the poorer one may want to try to stipulate that the buyout can be funded over time or with profits from the ongoing business.
In addition, the buy-sell should require a right of first refusal. That means if a partner finds an outside buyer for his shares, he must first offer those shares to the existing owners, who must match the outside buyer’s price. This shields the remaining partners from suddenly running the company with a dubious new owner.
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