The most important business document you will ever sign

The business owners must determine if a withdrawing owner is forced to sell and the business entity or other owners are forced to buy the business interest of the departing owner. In many circumstances it is appropriate to let a withdrawing owner maintain an ownership interest for investment and the sale or purchase is optional. Whether the sale provisions are mandatory or optional can be applied differently depending on the specific condition that triggers the sale.

Identifying the proper buyer will vary, but usually the buyer is the person or entity that has the cash to make the purchase, as well as the party that can accomplish the most favourable tax consequences. The buyout by another owner (the cross purchase) and the buyout by the company (the stock redemption) usually have the same tax consequences for the seller. Tax is owed on the seller's gain. The tax consequences on the buyer, however, can be vastly different, especially with regular or "C" corporations.

Since all business owners will eventually leave the business, taking advantage of the differences between using a cross-purchase or redemption buyout arrangement should not be ignored.

The agreement can be used not only to set the value of the company for sale purposes, but also for estate tax purposes. Given the difficulty of valuing a privately held business, an established sale price can eliminate argument with the IRS. If an owner fails to fix the value of the business, the IRS is free to use any of several valuation techniques that may determine a value substantially greater than what the owner believes the company is worth. Unless the sale of the business is to family members, the Buy/Sell Agreement will eliminate most arguments with the IRS.

If there is no established price, disputes can also arise among the remaining owners and the family of a deceased or disabled owner. Especially when the owner has been a key employee, the value of the business may be reduced because of the loss. Expenses may increase because of the need to replace the key employee. While the family is looking at the historical value to determine the buyout price, the remaining owners may look at the uncertainty of the future value. The business owner who wants to eliminate controversy with the IRS and be assured that his ownership value will be available for his family will make sure that the Buy/Sell Agreement establishes the value of the business.

No Buy/Sell Agreement would be complete without addressing payment terms. Unless the life or disability of the owner is insured, it is unlikely that the buyer has the cash to make the purchase, and the terms of payment must take this into consideration. Agreement must be reached on the length of the buyout period (usually three to seven years), the interest rate, and the security to ensure payment.

Seldom is there a ready-made market for a sole proprietorship business, particularly a service business. However, two or more owners of businesses practicing in the same profession such as lawyers, surgeons, CPAs, etc. can enter into business continuity agreements specifying how they will help each other in the event one of them suffers a disability or establish buy-out provisions in the event of death.

Some sole proprietorships may rely on key employees to carry on the business. Using a "stay" bonus can create the incentive for the key employees to help maintain the business until ownership can transfer or the business is liquidated.

The Buy/Sell Agreement that deals only with death and is perhaps funded by life insurance is merely a contingency plan. It will not serve as a business succession plan unless the owner dies during the term of the agreement.

A true succession plan must also deal with disability, retirement, termination of employment, the bankruptcy of the owner, or an owner's divorce.

Every owner of a closely held business needs to pull out the existing agreement to make sure all of these issues are covered.

You have worked hard in your business, and you owe it to yourself, your family and your employees to make sure that your plan is a business continuity plan.