As a business owner, have you considered what would happen if you could no longer run your company due to death or disability? Who would take over the management role? Would the business be sold? These questions just skim the surface of the many issues that would need to be addressed if a business owner were incapable of continuing to manage the company, especially if there are several co-owners.

Effective planning for continuity of ownership in the event of an owner’s death, disability or even retirement is vital to the survival of a business. A buy-sell agreement can help settle these issues before they arise and can be beneficial to all parties involved. This type of arrangement ensures a smoother transfer of ownership and lets the business carry on without disruption, even if some disputes occur.

These types of agreements can guarantee a buyer for a business interest and provide a fair price for the owner who is selling, as well as allow for orderly succession of ownership.

So what is a buy-sell agreement? It is a written agreement between two or more owners of a business and is based on a triggering event such as one owner’s death, disability or retirement. When such an event occurs, the agreement provides that one or more owners have an obligation to buy the business interest from the party who is “selling”.

A buy-sell agreement can be designed to provide for the financial and estate planning objectives of business owners. For example, surviving owners often want a way to quickly convert the business interest of the departing owner into cash. Such an arrangement can provide liquidity to the heirs of that owner while preventing them from receiving part of a business that they may not desire or be capable of managing. Furthermore, if an owner is disabled or retired, he or she could liquidate a business interest and have access to cash for living expenses.

There are several benefits to buy-sell agreements. These types of agreements can guarantee a buyer for a business interest and provide a fair price for the owner who is selling, as well as allow for orderly succession of ownership. In addition, a buy-sell agreement can insulate the remaining owners from intervention by the former owner’s heirs, which could be an uncomfortable situation.

The first step to creating a buy-sell agreement is to determine the value of your business. This value helps estimate future funding obligations of the parties involved in the arrangement.

There are several ways a business can be valued for a buy-sell agreement. For example, some arrangements specify a fixed price that is periodically adjusted as time goes by and the value of the business increases or decreases. Another method is to use a formula encompassing several factors of the business, such as book value, sales and earnings. This formula can be used to plug in the current figures at any time to determine the value. Frequently, the parties involved in a buy-sell agreement choose to consult an independent appraiser to establish fair market value.

As you can see, developing a buy-sell agreement is a significant responsibility for you as a business owner. You’ll need to address the legal, financial and tax-related implications of your buy-sell arrangement so it’s important to involve your legal and tax advisors, as well as your financial consultant, throughout the process.

Roy Larsen lives with his wife and two children in Cumming and is a Financial Consultant in the Alpharetta branch of A.G. Edwards & Sons, Inc., Member SIPC