November 12, 2019
Although no one likes to think about leaving their business, it is important to have systems in place for when you do. One document that I think is critical for every entity is a buyout or buy-sell agreement. A buyout agreement is a legal agreement between the owners of a business that spells out how the future sale or buyout of an owner's interest in the business will be handled.
A buyout agreement can be part of your partnership/corporate agreement or a standalone document. It is a binding contract about the future ownership of the business. The buyout agreement will explain in detail if the departing partner/shareholder must be bought out and for how much. It will also dictate who can buyout a partner/shareholder and what type of event will trigger the sale.
Trigger events could include a partner’s/shareholder’s:
- Retirement
- Resignation
- Sickness, disability or death
- Personal bankruptcy
- Foreclosure of a debt secured by a partnership interest
- Divorce (if the ex-spouse could receive partnership/shareholder interest)
If you do not have a buyout agreement, you could be forced to dissolve the business if a partner/shareholder decides to move on to another opportunity. Or you could be in a situation where a surviving spouse or child inherits interest in the entity, and you will have to work alongside of that person. This situation can bring all kinds of issues into play.
A buyout agreement is frequently used to fund a partner’s/shareholder’s retirement. If done correctly, the buyout agreement will provide a sense of security for the partner/shareholder and his/her family. Even so, it is imperative that partners/shareholders follow the rules to ensure the funds will be available to them. This includes giving proper notice of a pending retirement, training the person who will take over, and ensuring that customers are aware of the transition and willing to work with the new partner/shareholder.
A buyout agreement is not a savings plan. Partners/shareholders should not plan on cashing out when they want to leave the company. Instead, a buyout agreement is meant to keep partners/shareholders in the game for the long-term.
The best buyout agreements make the deferred compensation contingent on the value the partner/shareholder brought into the organization. Performance-based goals will make sure that the partner/shareholder makes a sustainable contribution to the success of the company.
Typically, new partners/shareholders are required to buy into an entity. This ensures that the new partner/shareholder has an investment in the company. It also helps with the eventual transition of ownership and customers to the next generation.
To be successful, the math must add up in a partner/shareholder buyout agreement. New, existing, and retiring partners/shareholders all need to be supported by the activities of the company. It is therefore essential to establish realistic and reasonable terms.
Feel free to call any member of our team to discuss how to structure your buyout agreement at 610-828-1900 (PA) or 732-341-3893 (NJ). You can contact Rich Higgins, CPA, managing principal – New Jersey office at
[email protected]
or me at
[email protected]
. We are always happy to help.
Martin C. McCarthy, CPA, CCIFP
Managing Partner
McCarthy & Company, PC
Disclaimer: This alert is for informational purposes only and does not constitute professional advice. Information contained in this communication is not intended or written to be used as tax advice, and cannot be used by the recipient to avoid penalties that may be imposed under the Internal Revenue Code. We strongly advise you to seek professional assistance with respect to your specific issue(s).
